Full episode: Market Call for Wednesday, October 4, 2017
Jerome Hass, Portfolio Manager at Lightwater Partners
FOCUS: Canadian Mid-Caps
Everyone gets the concept of ‘buy low, sell high’ but it’s surprising how few investors put it into practice. Why is this? Let’s start with the price chart: people like to be associated with a winner. Investors like to buy a stock with an attractive historical price chart so they chase past performance because most do not have the ability to forecast earnings forward. Conversely, who wants to buy a stock with an ugly price chart? No one wants to ‘catch a falling knife’ so investors generally balk at the opportunity to ‘buy low’.
The role of broker or ‘sell-side’ analysts is another factor to consider. When a stock price is rising it is common to see target prices and recommendations rising. One of our top picks today has 12 sell-side analysts covering the stock. When the stock hit its all-time peak at $12 six months ago, the stock had a ‘pretty’ price chart: it was up over 189 per cent over the prior 12 months. Not surprisingly, there were 10 BUY recommendations and 2 HOLDs on the stock at that time with an average target price of $11.24 (8 per cent below the share price). Fast forward to today, the price has fallen 75 per cent to $3. The average target price is 57 per cent above the current share price yet only 7 out of 12 analysts rate the stock a BUY.
Do not be taken in by price charts, price targets or analyst ratings. Independent fundamental analysis is a proven way for investors to consistently ‘buy low and sell high’.
CRH MEDICAL (CRH.TO)
Canadians have been spoiled for choice when it comes to terrible healthcare investments: Valeant, Patient Home Monitoring, Concordia, Nobilis Health . . . The CRH price chart suggests it is following this dubious tradition. We think not. CRH is a play on aging U.S. baby-boomers and the growing need for colonoscopy procedures. CRH provides anesthesia services in private clinics where colonoscopies are performed. This is normally a stable business with predictable cashflows and high ROEs. Unfortunately, the medical body that sets reimbursement prices in the USA lowered rates by 15 per cent in August and added new billing codes. Management estimates the net impact will be an 8per cent decline in organic revenues and 14 per cent in EBITDA in 2018. Bad news indeed, but the 75 per cent drop in its share price from its peak suggests an over-reaction. At 6.5 times next year’s EV/EBITDA, we see significant upside to a 10 times sector multiple. [We last added to the stock at $3.22 on August 9th]
This stock is one of the few pure plays on the growth of e-commerce in Canada. As customers increasingly shop online, they demand rapid receipt of packages; Cargojet is the dominant player in time-sensitive air freight. CJT is a little-known company that operates a natural monopoly in overnight air delivery of cargo, letters and packages with about a 90+ per cent market share. Its customers include Canada Post, UPS, DHL, Air Canada, Amazon and Purolator among others. According to recent estimates, online shopping in Canada only represents about 4.5 per cent of retail sales, lagging behind the USA at 11.5 per cent and the U.K. at 15 per cent. E-commerce driven volumes, including companies like Amazon, are driving in excess of 50 per cent YOY growth for the past couple of years and are continuing at an accelerated pace. Hence, we think there is a lot more growth to CJT’s business than the street realizes. We also see value in the stock: it currently trades at 6.0 times multiple (2018E EV/EBITDA) while trucking companies trade at 7.5 times. We believe CJT should trade at a premium to the trucking sector, especially given its monopolistic position. [We added to CJT on October 2nd at $49.99]
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 Top 10 globally with sales in over 60 countries. The stock recently dipped down on the news that Toys ‘R’ Us was filing for bankruptcy. However the chain represents only 15 per cent of revenue and is decreasing each year to rivals such as Wal-Mart, Amazon, and Target. The US toy market grew by 5 per cent last year, and Amazon’s toy sales grew by 24 per cent, while Toys R Us grew by only 2 per cent. As the holiday season approaches we expect strong performance from Spin Master over the next two quarters with many toys listed on the recently published “Hot 2017 Toys List” and the upcoming Hatchimals Day on October 7th. While the focus remains on toy sales it is worth remembering that Paw Patrol is the top ranked pre-school animated show around the world and is now in its 4th season. We continue to think the pipeline of shows, toys, and licences is large enough to maintain double digit growth. The stock is up 49% YTD and is now trading at 25x 2018 EPS estimates. [We last added to our position in July at $38.15].
*SHORT* ELECTROVAYA (EFL.TO)
One of our favourite children’s stories is “The Emperor’s New Clothes” by Hans Christian Andersen. Everyone pretends to admire the clothes except one little boy who yells out "But the Emperor has no clothes." As we pointed out in our short thesis on Electrovaya 15 months ago, the stock market is an expensive place to learn the lessons of life. It would be a lot cheaper to re-read children’s books instead.
- Then: $4.15
- Now: $1.05
- Return: +74.69%
- Total return: +74.69%
DESCARTES SYSTEMS (DSG.TO)
Every portfolio should have a few low-maintenance stocks and Descartes is a good example. At the beginning of each quarter, it knows where 90 per cent of its revenues will come from (its recurring revenue stream). It spends the next 90 days delivering the other 10 per cent. Investors like Descartes’ predictability and consistency, combined with steady growth. DSG is a play on rising global trade and increasing trade compliance. It always trades at a pricey valuation but it is a steady long-term holding.
- Then: $24.24
- Now: $34.13
- Return: +44.92%
- Total return: +44.92%
We have held Enercare since early 2010. What was then an under-followed and unloved stock has grown into a favorite among institutional investors. We like the solid cash flows generated by the water-heater business. The sub-metering business has a similar capex and cashflow profile as the water-heater business but the Street is still not factoring the growth of the sub-metering business into future earnings. ECI is a great long-term holding for income seeking investors.
- Then: $17.20
- Now: $20.74
- Return: +20.58%
- Total return: +27.57%
TOTAL AVERAGE RETURN: +49.06%
LIGHTWATER LONG SHORT FUND
1 Year: 0.34% Fund, 4.21% Index*
3 Year: 3.98% Fund, -0.89% Index*
5 Year: 11.11% Fund, 4.95% Index*
* Index: S&P / TSX Composite Index.
** Returns provided are net of all fees and expenses. 3 and 5 year figures are annualized returns