Jul 26, 2016

William Chin's Top Picks: July 26, 2016

BNN Bloomberg

William Chin , BNN

William Chin, Portfolio Manager, Caldwell Investment Management

FOCUS: Technical Analysis & Macro Portfolio Strategy

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MARKET OUTLOOK:

The overall sentiment in the financial markets is mixed. Commodities are lower, particularly crude oil, and that took our dollar lower versus the U.S. dollar as well (which is in my forecast. I write a USD/CAD update every week). Part of that was due to the devaluation of the Chinese currency. The cheaper yuan allows China to more efficiently export their glut of commodities-based, intermediate goods to the rest of the world, including of course, petroleum-related goods.

The S&P 500 has made new highs, but it is a market of stocks. The divergence in performance of individual stocks is unusually large. A good stock picker is always nice to have, especially these days. There are expectations of “helicopter money” – the government will issue bonds with no maturities for the Bank of Japan to buy them, effectively printing money and handing it over to the government. The Bank of Japan is what I call “the Keith Richards of central banks”. These expectations certainly have a hand in pushing U.S. stocks to new highs.

In the interest rate complex, I expect bond yields to remain range bound because growth and inflation are both very tame. Bond yields fell to unsustainably low levels after Brexit and we have seen bond yields coming back up, that is, bond prices falling. My Government Bond fund (The Caldwell Income Fund) has been in cash (that is Treasury bills) and is now ready to pick up the bargains soon. The Caldwell philosophy in bonds is to pick up capital gains through active management. We don’t buy bonds and hold them for their low yields; we actively manage them for capital gains.

A recent Bloomberg article pointed out there is likely a US$ 3 trillion pent-up demand in government bonds because pension funds are very much under-invested in bonds. So, there is no bond bubble, only pent-up demand. The Federal Reserve’s Flow of Funds report for Q1 2016 showed that “Defined benefit pension funds” only hold 6.3 per cent government bonds in their portfolios. They need to be at least 20 per cent if not 30 per cent or 40 per cent in bonds, according to different risk management and actuarial models.

Top Picks:

Clearwater Seafoods (CLR.TO)

Clearwater is the largest vertically integrated harvester, processor and distributor of premium shellfish in North America, operating in the United States, Canada, Europe, Asia, and Argentina. They provide fresh and frozen seafood, including scallops, lobster, clams, coldwater shrimp, crab, and groundfish. We like Clearwater for the following reasons:

Strong increase in the global demand for shellfish. This is due to a shifting of consumer tastes towards healthier/protein-oriented diets and a rise in purchasing power of middle- class consumers in emerging countries.
Global demand is outpacing supply. This is creating a favorable pricing environment for the industry.
Supply and scale advantage. Clearwater is in a great position to capitalize on these trends given their supply and scale.
Accretive acquisition. In late 2015, Clearwater announced a very accretive acquisition of a leading European shellfish company, MacDuff, which significantly increases their supply and enhances their global position.

Hardwoods Distribution (HWD.TO)

Hardwoods is one of the largest distributors of lumber in North America, mainly participating in higher-grade lumber. 60 per cent of products are used in new residential construction in the form of cabinets, mouldings, custom finishing, furniture and the remainder is not associated with new resi construction (home renos, millwork/interiors for offices, restaurants, schools, hospitals, etc.). We believe Hardwoods will continue to benefit from the following:

Their continued penetration of the U.S. commercial market. They recently made a large and accretive acquisition that helps in this regard.
Exposure to the U.S. residential and commercial construction markets. The majority of their revenue comes from the U.S., which currently has a very strong housing market.
Relatively undervalued. Despite strong growth prospects (both organically and through acquisition), Hardwoods trades at a considerable discount to the market.

ZCL Composites (ZCL.TO)

ZCL is a manufacturer and supplier of fiberglass-reinforced plastic used in storage tanks. We like ZCL Composites for the following reasons:

Oil and gas exposure misunderstood. The bulk of ZCL’s revenue comes from petroleum storage at gas stations (not affected by low oil prices). Their actual exposure to low oil prices has come down considerably over the past few years and is currently only 10-15 per cent. We believe their oil exposure is misunderstood and this has caused ZCL to trade at an attractive multiple.
Sustainable growth story. Their fiberglass product is viewed as superior to the steel and concrete alternatives given that it does not corrode. There is a large replacement market opportunity in the petroleum storage market given the general aging of tanks and also an opportunity on the construction side in the water storage market.
Better competitive positioning. There is generally not a lot of competition in the industry and there are substantial barriers to entry. Also, ZCL has scale and operational advantages over existing competitors.