Don Lato, president of Padlock Investment Management
Focus: North American equities

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MARKET OUTLOOK

For anyone who missed volatility, it’s come back with a vengeance since my last Market Call appearance in late January. Although unsettling for investors, the volatility has not diminished Padlock’s constructive outlook for the balance of the year. The volatility was sparked by the default of some financially engineered products and has continued during the lull between corporate earnings seasons. Early earnings reports this quarter have been very encouraging. After enjoying a few years of multiple expansion, this market will be hard-pressed to rise from more of it, but should continue its advance based on the growth in earnings this year.

Economic fundamentals remain solid, interest rates are still very low by historical standards and any sense of excess optimism on the part of investors has been curtailed by the recent price action.

TOP PICKS

HI-CRUSH PARTNERS (HCLP.N)
Last purchased on July at $10.

Hi-Crush is a U.S. supplier of “frac” sand to the energy service companies. With facilities in Wisconsin and the newly opened Kermit facility in the Permian, the company is well positioned to serve the major U.S. exploration areas. The Kermit facility has first-mover advantage in the Permian by being the first on-site sand facility in the area to be fully permitted and in operation.

Barriers to entries in the industry are low and that’s something that it grapples with during periods of lower demand. Frac sand usage is expected to rise in the U.S. this year as more wells are drilled, each one using more sand in the fracing process.

Hi-Crush, which currently yields 6.7 per cent, reinstituted their distribution in Q4/2017, raised it in the first quarter of this year and has pledged to increase it by 10 per cent per quarter. Because Hi-Crush is a limited partnership and faces 40 per cent withholding tax for Canadian investors, it’s best-suited for a non-registered account.

TD BANK (TD.TO)
Long time holding, no recent purchases.

TD Bank has been a core holding of the Padlock portfolios for many years. Facing a number of issues such as NAFTA and the country’s energy woes, the Canadian banks have been slow to recover from the initial shock to the markets in late January.

The bank is well positioned in the U.S. to take advantage of the strengthening economy and the better spreads as interest rates rise. After accounting for the short-term tax impact of the U.S. tax changes, TD will now benefit from them.

For an oligopoly, valuations of Canadian banks have remained favourable. With the recent decline, TD Bank id at 10.5 times October 2019 earnings. Yielding 3.8 per cent, this represents a solid entry point.

ULTA BEAUTY (ULTA.O)
Purchased earlier this week at $228.

Ulta Beauty is one of the leading cosmetics retailers in the U.S. through its 1,074 stores and strong online presence. With an estimated 100 new stores to open this year and same-store sales still very strong as evidenced by the 6.5 per cent increase in the last quarter, the company is well positioned to continue to have solid earnings growth.

Over the last few years, Ulta had been a market darling until it got “Amazoned” last June. After reaching an all-time high at $315, concerns about Amazon’s new focus on the cosmetics business caused the whole group and high-multiple Ulta in particular to have a significant selloff. Competitive pressures will continue to exist, but the decrease in the price-to-earnings multiple from over 30 times then to now 18.5 times next year’s earnings makes for an attractive entry point, considering the still=strong earnings growth that is expected.

PAST PICKS: NOV. 30, 2017

PAREX RESOURCES (PXT.TO)

• Then: $17.24
• Now: $20.95
• Return: 22%
• Total return: 22%

SLEEP COUNTRY CANADA (ZZZ.TO)

• Then: $32.63
• Now: $33.24
• Return: 2%
• Total return: 2%

WALGREEN BOOTS ALLIANCE (WBA.N)

• Then: $72.76
• Now: $64.18
• Return: -12%
• Total return: -11%

Total return average: 4%

FUND PROFILE

Padlock Growth Composite as of March 31, 2018

• 1 month – composite -2.02%, benchmark -1.03%
• 1 year – composite 2.38%, benchmark 6.14%
• 3 year – composite 9.05%, benchmark 7.88%

*Benchmark is 50% S&P/TSX Total Return Index and 50% S&P 500 Total Return Index in CAD$.

TOP 5 HOLDINGS AND WEIGHTINGS

1. Apple: 8.1%
2. Parex Resources: 7.8%
3. Alphabet: 7.3%
4. Visa: 5.2%
5. New Flyer Industries: 4.5%

WEBSITE: www.padlockinvestment.com