Colin Stewart's Top Picks: June 8, 2016

Colin Stewart, CEO & Portfolio Manager, JC Clark Limited

FOCUS: North American Large Caps and Long/Short Strategies

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MARKET OUTLOOK:

While we remain relatively optimistic on the outlook for the U.S. economy and are encouraged by continuing improvements in unemployment and the key housing sector (further supported by very strong April housing starts), we believe market volatility will remain high in the near-term and that a somewhat cautious approach is warranted.  With the resilience in equities, overall valuation levels are at or above historic averages, and macroeconomic risks are high. We remain concerned about a potential slowdown in China, the upcoming U.S. election cycle, and the potential for Britain to exit the EU. Corporate earnings remain mixed and with profit margins near record levels, there is risk that future earnings will not meet expectations, thereby applying pressure to valuation multiples across a variety of sectors. 

Top Picks:

Capital Senior Living (CSU.N) – Last purchase in early June at approx. $18.50/sh.

• Owner/Operator of Seniors Homes in the U.S. (Southeast, middle America)
• Strong growth outlook supported by demographics, acquisition strategy and pricing power
• Cash flow/sh. growth of 20 per cent+ over last 5 years, 90 per cent occupancy, 2.5 per cent annual rate increases
• Own over 60 per cent of real estate, conservatively financed with low-cost mortgage debt, 98 per cent private pay business model
• Trades at discounted valuation to Canadian comps (Chartwell, Extendicare), and at discount to U.S. Healthcare REITs

QHR Corp. (QHR.V) – Last purchase in early June at approx. $1.70/sh.

• QHR is the second largest EMR (Electronic Medical Records) provider in Canada with over 7,000 physicians currently on the platform
• Highly predictable recurring revenue model (Saas) and customers are very sticky (Doctors don’t like switching products once they’ve gotten used to one) – evidenced by 2 per cent customer churn rate
• EMR is under-penetrated in Canada at 65 per cent versus around 90 per cent in other developed countries in Europe and the U.S. – good runway to add more customers
• Growth drivers – adding 1,000 physicians per yr., new product introductions, potential data monetization in the future
• Recent Telus announcement is meaningful – partnership could forge pathway to QHR becoming the exclusive front end provider while Telus manages the back end – or even an eventual acquisition of QHR outright
• Valuation: we see a pathway to get to 10,000 doctors and 20 percent EBITDA margins over the next 3 years.  Would put the implied valuation at 9x EBITDA – way too cheap for this type of business. SaaS providers typically trade at double that multiple.  EV/Rev multiple tells the same story with QHR at only 2.0x vs 4-5x for SaaS peers

Imvescor Restaurant Group (IRG.TO) – Last purchase in early May at approx. $2.45/sh.

• One of the largest restaurant franchisors in Canada with 225 locations mainly in Quebec and Atlantic Canada
• Brands include:  Pizza Delight, Baton Rouge, Mikes, and Scores
• Franchise model highly attractive – capital light, strong free cash flow, pays a healthy 3.5 per cent dividend yield
• CEO Frank Hennessey executing on turnaround plan – comp store sales improving, restaurants being refurbished, focusing on basics such as menu, purchasing, training, etc.
• Strong balance sheet creates flexibility to grow through acquisition, maintain/grow dividend
• Trades at discount to group 

Past Picks: JUNE 12, 2015

Merus Labs (MSL.TO)

• Then: $3.31
• Now: $1.65
• Return: -50.15%
• TR: -50.15%

Cargojet (CJT.TO)

• Then: $25.66
• Now: $31.60
• Return: +23.15%
• TR: +26.22%

Richards Packaging (RPI_u.TO)

• Then: $16.02
• Now: $25.28
• Return: +57.80%
• TR: +66.05%

Total Return Average: +14.04%

Website: www.jcclark.com