Aug 23, 2018

Don Lato's Top Picks: Aug. 23, 2018

BNN Bloomberg

Don Lato , BNN Bloomberg

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

MARKET OUTLOOK

There has been a lot of talk this week about the current bull market in the U.S. being defined (under some measurements) as the longest ever. Padlock remains unconcerned about the length and focuses more on the underlying fundamentals, valuations and investor sentiment, which all remain favourable. The reporting season that’s just wrapping up once again was very solid, valuations on a forward earnings basis for the S&P 500 index and for most stocks aren’t extreme and investors are still stilling with trillions of dollars of cash and continue to look for reasons to why the next market crash is just ahead.

Given that this week’s news cycle may have been the worst ever for this presidency, I’ve been particularly impressed by the markets resiliency in the face of this news in spite of the president’s assertion that markets will indeed crash if he’s impeached.

There are obvious concerns such as overall trade issues and the future of NAFTA, but these and other concerns do override the still favourable risk/reward of being invested in equities.

TOP PICKS

HI-CRUSH PARTNERS (HCLP.N)
Last purchased in June at $12.25.

On July 23, Hi-Crush announced that they would be increasing their quarterly distribution from 22.5 cents to 75 cents per quarter as part of their plan to convert from a limited partnership to a corporation. After initially being well received by the market (it went up 46 per cent in a week), the stock has sold off as concerns about increased sand supply in 2019 have weighed on the stock.

In order to convert to a corporation, the LP must pay out a distribution at this level for four consecutive quarters. The first 75 cent distribution has been received with the remaining three quarters still to come. Should the conversion to a corporation occur, investors should not count on this level of dividends continuing, but should still expect a healthy one going forward.

Increased supply for the industry is a reality, but Hi-Crush is well positioned with a number of long-term contracts at very profitable prices. The pending conversion may be causing upheaval in the shareholder base, which is presenting a great entry point for both short and long term investors.

PAREX RESOURCES (PXT.TO)
Last purchased last week at $19.10.

After being the best performing energy stock in Canada this year, since the July 17 announcement by Parex that they would be examining the sale of their development properties in Colombia and returning to their roots and strength of being an exploration company, the share price has come under pressure. The initial weakness was further enhanced earlier this month by the news that Parex had abandoned two wildcat wells. This news accompanied an otherwise solid second-quarter earnings release that included guidance for an increase in overall production this year.

The area of the dry holes wasn’t part of the development package that’s for sale and prior to the news had net asset value estimates of 30 to 50 cents a share. Nonetheless, investors have clearly overreacted to this combination of news and are overlooking the tremendous cash flow (estimated at $5.21 per share for 2019) that Parex continues to generate. The company should also be of great interest to a variety of potential acquirers.

My overall investment view is that stocks are generally priced rationally, but have periods of irrationality that must be taken advantage of. The current irrationality around Parex is presenting a tremendous buying opportunity that must be acted upon.

SLEEP COUNTRY (ZZZ.TO)
Last purchased in June at $33.60.

Sleep Country was a market darling from its 2015 IPO until last summer. In spite of very solid earnings growth during the past year, the stock has been an underperformer since that time.

In its last earning release, Sleep Country reported year-over-year growth of 8 per cent, 13 per cent and 14 per cent in revenues, EBITDA and earnings per share respectively. Same-store sales (SSS) growth was still a very solid 4.4 per cent (in spite of the dreadful April weather that impacted many of its locations), but was less than the consensus expectations of analysts. The company continues to expand the number of locations and that, in combination with continued SSS, should provide for solid earnings growth into next year and beyond.

At current prices, the stock is trading at 15.4 times next year’s earnings per share and yielding 2.4 per cent, with reasonable expectations for dividend increases possibly later this year and the next. This valuation presents a very good entry point for becoming a shareholder in one of Canada’s strongest long-term growth stocks.