Full episode: Market Call for Monday, November 13, 2017
Brendan Caldwell, president and CEO of Caldwell Investment Management
FOCUS: Canadian value stocks
Canadian and U.S. markets have continued to grind higher despite investor fears that markets will correct. This is just the latest in a string of examples of how difficult it is to time a market, especially when fears are driven by headlines and geopolitical concerns. Most U.S. companies have now reported third quarter results, with a higher percentage beating expectations on both the top and bottom lines than in prior quarters. However, the market’s reaction to "beats" has become more muted, while the reaction to "misses" has strengthened. In today’s low growth and higher valuation world, we continue to recommend investment strategies that own fewer stocks targeted at specific companies or areas of the market, versus strategies that closely resemble the broader markets. Companies benefiting from strong secular trends or that have company-specific levers to drive value creation (i.e. things that are within management’s control as opposed to having to rely on economic growth or a continued market rally) are our focus.
CGI GROUP (GIBa.TO)
CGI Group manages IT and business process services for clients, including outsourcing and system integration/consulting.
We like CGI Group for the following reasons:
- Strong secular trend for consulting. As the global environment becomes increasingly competitive and as the technological landscape becomes increasingly complex, companies are increasingly relying on IT consulting firms like CGI to stay competitive. We see this as a trend that will continue for the foreseeable future.
- Improving growth profile. Organic growth and future bookings have improved in recent quarters. We believe growth will continue to improve on better spending in several markets, with particularly strong demand in digitalization. Furthermore, CGI has winded down much of their lower margin contracts and are replacing these with higher margin contracts.
- Potential M&A. CGI has a strong track record of acquisitions. The pipeline remains strong with several large potential deals available and CGI has the means to pursue such acquisitions if they are a good fit.
CHORUS AVIATION (CHR.TO)
Chorus operates three businesses:
- A capacity purchase agreement (CPA) with Air Canada. Through the CPA, Chorus operates Jazz Airline under a fixed fee arrangement. This agreement accounts for 70 per cent of Air Canada's regional capacity with a fleet of 113 aircraft and accounts for the majority of Chorus' revenue.
- Maintenance repair overhaul. They perform a comprehensive range of services such as aircraft inspections, installations, repairs, and inventory management.
- Regional aircraft leasing. Utilizing a $200 million capital injection from Fairfax Financial, Chorus recently created a new division, Chorus Aviation Capital (CAC), where they buy regional aircraft and lease them out to regional operators globally. This is currently a small portion of Chorus' revenue but has considerable growth potential.
We like Chorus for the following reasons:
- Diversifying away from CPA towards growth. Chorus is a strong operator that has executed very well on their CPA agreement with Air Canada. While the business is a stable cash flow generator, it has little growth opportunities. For this reason, Chorus is pursuing their regional aircraft leasing business. The leasing business has a long runway of growth, which should spark increased interest from investors.
- Leasing is an attractive opportunity for Chorus. There are several reasons for this:
- Passenger traffic is expected to exhibit strong growth over the next 20 years (driven by emerging markets) which will drive strong demand for new aircraft from airlines;
- Aircraft leasing is an attractive option for airlines as it is less capital intensive, gives fleet flexibility, and eliminates residual value risk;
- Chorus is only competing in regional aircraft, where leasing remains under-penetrated and where they will face limited competition from major leasing players;
- Chorus has substantial competitive advantages in that they already lease planes to Air Canada under their CPA, they are an experience operator with strong OEM relationships, and that they repair aircraft internally
- Valuation. We believe Chorus will get an upwards multiple re-rate as they execute on this strategy, given that aircraft leasors tend to trade at a premium to airline operators.
EMPIRE COMPANY (EMPa.TO)
Empire Company is a food retailer through wholly-owned subsidiary Sobeys. Sobeys owns/franchises 1500 stores in 10 provinces under retail banners of Sobeys, Safeway, IGA, Freshco and others, as well as 350 retail fuel locations.
We like Empire Group for the following reasons:
- Turnaround story. Empire has struggled over the past several years due to a series of operational miscues - mainly their poor integration of the 2013 Safeway acquisition (for example, elimination of the Safeway private label brand/loyalty program, both popular with customers) - but also heightened promotions which deteriorated margins. Empire has recently brought in an experienced and operationally-focused senior management team that put "Project Sunrise" in place - a plan that aims to save $500 million annually by 2020 through various cost saving measures (corporate re-structuring, shift to centralized from current regional structure, new IT systems, improved procurement process with vendors). We believe the stock will react positively as they execute on this plan.
- Recent improvement in top line. After an extended period of deflationary grocery environment in Canada driven mainly by an influx of competition, the industry appears to have stabilized (evidenced by a recent return to food inflation) as the market has better absorbed the competition. This return to inflation combined by several marketing and pricing initiatives of the new management team has had a positive effect on Empire's same store sales. This is a trend we believe will continue in the near future.
PAST PICKS: JULY 14, 2016
IMVESCOR RESTAURANT GROUP (IRG.TO)
- Then: $2.79
- Now: $4.03
- Return: 44.44%
- Total return: 49.25%
IBI GROUP (IBG.TO)
- Then: $5.15
- Now: $7.77
- Return: 50.87%
- Total return: 50.87%
CALIAN GROUP (CGY.TO)
- Then: $20.08
- Now: $32.09
- Return: 59.81%
- Total return: 68.71%
TOTAL RETURN AVERAGE: 56.27%
Caldwell Canadian Value Momentum Fund
Performance as of: October 31, 2017
Year to date: 12.9% fund, 7.3% index
1 Year: 14.8% fund, 11.5% index
3 Year: 12.8% fund, 6.2% index
5 Year: 13.6% fund, 8.4% index
*Index: S&P/TSX Total Return Index
TOP HOLDINGS AND WEIGHTINGS
- CGI Group: 5.9%
- New Flyer Industries: 5.7%
- Imvescor Restaurant Group: 5.6%
- Transcontinental: 5.6%
- WSP Global: 5.6%