Market Call for Wednesday, March 8, 2017
William Chin, portfolio manager at Caldwell Investment Management
Focus: Technical analysis and macro portfolio strategy
The Trump administration will bring us lots of changes, and the markets are still in the process of discounting the future impact. We all have to deal with uncertainties and, inevitably, volatility.
At Caldwell Investment Management, we emphasize active management. That is, we take a pro-active approach to find value for our clients and investors. This includes a strong emphasis on capital preservation. Apart from managing fixed income at Caldwell, my other role as the chief technical analyst has kept me very busy. When properly applied, technical analysis can turn volatility into your friend. Apart from following and guessing what is coming, why not follow the money? That is also the reason I employ multi-market analysis, following all four of the major asset classes — stocks, bonds, currencies and commodities. When big money moves through the market, it often crosses asset classes. If you follow all of them, you will be one or two steps ahead of your peers, giving you a great edge.
One of my roles is to help out on the Caldwell Canadian Value Momentum Fund with technical analysis, macro analysis and execution. The lead manager is Jennifer Radman, one of your regulars.
The Caldwell Canadian Value Momentum Fund is a model-based Canadian equities fund. The model identifies stocks with good valuation that are just starting to be appreciated by investors — a great combination of both value and momentum. Given that these stocks exhibit company-specific catalysts, they are generally more immune to general market volatilities. The strong sell discipline in the model also ensures that should one of our holdings become negatively impacted by new developments, the stock will be gone from the portfolio. This sell discipline acts as an automatic stop loss. As a result, the Fund has a strong down capture of only 35 per cent. The Fund’s five-year return is 11.2 per cent, compared with the TSX’s 7.2 per cent.
SLEEP COUNTRY CANADA (ZZZ.TO)
Sleep Country is a leading mattress retailer in Canada and the only specialty mattress retailer with a national footprint. Mattresses account for approximately 80 per cent of sales, with the remainder coming from mattress/bed accessories. We like Sleep Country for the following reasons:
- Increasing penetration of accessory sales: Sleep Country is in the early innings of rolling out higher-margin accessory products (sheets, duvets, headboards, etc.). The traction here has been impressive and they continue to increase the focus on growing accessory sales.
- Store redesigns: The goal is to refresh 15-20 stores a year with more modern layouts that better highlight key products. The results have been very positive and are expected to continue to be a positive catalyst to sales.
- Competitive landscape: Sleep Country continues to take share from competitors through strong execution, and we expect this trend to continue. They have been able to take shares from several key competitors such as Sears Canada (struggles there have been well noted) and Hudson’s Bay (they have done well on their turnaround effort but mattresses are not an area of focus for them), as well as smaller regional players.
Transcontinental is Canada’s largest printer with operations in print, flexible packaging, publishing and digital media. The bulk of their operations is associated with the printing and distribution of retail flyers and newspapers. They have also been expanding their footprint in the flexible packaging industry, which is their higher growth segment.
We like Transcontinental for the compelling valuation. Transcontinental trades at a significant discount to the market driven by their exposure to print, which is in secular decline. We believe the stock warrants a higher multiple for several reasons:
- Misunderstanding of print segment: Some, if not most, investors do not properly understand their print segment and it is possible they assume much of it is in secular decline. However, much of the business, particularly that linked to retailers (per management, it is 65 per cent of print), is generally performing well. Furthermore, they are also relatively well positioned in the parts that are in secular decline. For example, past investments, combined with Transcontinental’s ability to remove cost through print platform optimization, have left them with a strong, low-cost manufacturing footprint that enables them to take share of a declining newspaper industry as publishers continue to outsource ("last man standing"). Management has placed some focus on better explaining this to investors, which we believe will be well received.
- Exposure to flexible packaging: Packaging companies trade at a much higher multiple than print due to the growth characteristics of the industry. Transcontinental continues to leverage their strong manufacturing expertise to grow their packaging business both organically and through acquisition. This segment should continue to grow and account for a higher percentage of revenue.
- Strong free cash flow: We like Transcontinental's strong free cash flow generation as it highlights the efficiency of their operations. It also provides financial flexibility, which will be important as they grow their packaging business.
Cargojet provides time-sensitive overnight air cargo services mainly within Canada (they have a 90-per-cent market share in Canada) but also internationally. They operate 22 aircraft and have facilities in each of 14 Canadian cities they serve. Major customers include UPS, Canada Post, Puralator, FedEx Express, Amazon and Transforce. We like Cargojet for the following reasons:
- Low downside risk: We view this as a stock with low downsize risk for several reasons: a) there are significant barriers to entry (major investments in fleet/terminals, geographic reach, regulatory guidelines, etc.) that we believe will allow Cargojet to maintain their strong market share; b) 75 per cent of their core domestic revenue is guaranteed; c) they have sticky relationships with customers that are tied to long-term contracts.
- Increasing free cash flow profile: Cargojet is in the late stages of an investment cycle, which was required after signing a major long-term contract with Canada Post in 2014. As their capital expenditure investment normalizes over the next couple of years, Cargojet will see a considerable uptick in free cash flow.
- Network optimization: Cargojet is currently optimizing their fleet to better utilize their planes. This includes better routing of existing flights as well as securing new customer deliveries during plane downtimes. The result will be a better margin profile.
PAST PICKS: SEPTEMBER 16, 2016
IMVESCOR RESTAURANT GROUP (IRG.TO)
- Then: $3.11
- Now: $3.37
- Return: +8.36%
- TR: +9.88%
SLEEP COUNTRY CANADA (ZZZ.TO)
- Then: $30.99
- Now: $32.61
- Return: +5.26%
- TR: +6.37%
AGT FOOD AND INGREDIENTS (AGT.TO)
- Then: $36.23
- Now: $31.97
- Return: -11.57%
- TR: -10.85%
TOTAL RETURN AVERAGE: +1.80%
- 1 month: Fund -0.4%, Index* 0.2%
- 1 year: Fund 21.6%, Index* 23.2%
- 3 years: Fund 6.1%, Index* 5.8%
- 5 years: Fund 11.2%, Index* 7.2%
- Since inception (August 15, 2011): Fund 11.0%, Index* 6.7%
* Index: S&P/TSX Composite Total Return Index
TOP HOLDINGS AND WEIGHTINGS
- Imvescor Restaurant Group: 6.6%
- New Flyer Industries: 6.2%
- Boyd Group: 6.1%
- CCL Industries: 6.0%
- Cargojet: 5.9%