Jan 12, 2017

James Telfser's Top Picks: January 12, 2017

BNN Bloomberg

James Telfser , BNN

James Telfser, partner and portfolio manager at Aventine Asset Management

Focus: Canadian equities
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MARKET OUTLOOK
Frequent followers of our commentaries and outlooks will have noticed that the Aventine Canadian Equity Fund’s exposure to cyclical value companies increased significantly in the second half of 2016. We continue to hold this view and also sit more fully invested now versus anytime over the past couple years. The positive macroeconomic trends we saw develop early in the fall have continued. We view this data as much more actionable now, though, given the cloud of uncertainty that has been removed as a result of the U.S. election. We see very encouraging trends in global economic momentum, most notably the data from PMI surveys which are at multi-year highs in the U.S., Europe and China. This bodes well for resurgent corporate profitability, which has already been improving and will benefit from weak base effects in the first half of 2017. The improvements should be particularly strong in the industrial, resource and financial sectors.

In terms of risk, financial conditions remain supportive of long positioning in equities. Despite the higher government bond yields, credit spreads continue to narrow and volatility remains subdued. Long-term investors should be comfortable holding positons and letting the market grow into its above-average valuation as the E in the P/E ratios rises sharply this year and next. More tactical traders may look to take advantage of event volatility around the U.S. presidential inauguration, if any materializes. In the ACE Fund, we continue to favour cyclicals and base metals over defensives and gold. High-quality stocks have been out of favour for the past 12 months, which we expect to continue, so look for catalyst-rich names here to outperform as multiple expansions will be much easier to realize elsewhere.

TOP PICKS

ROCKY MOUNTAIN EQUIPMENT (RME.TO)
Rocky Mountain runs an independent dealer network in Canada for new and used agricultural and industrial equipment. While there was a surge in equipment purchases during the years 2012-2014, the following years brought inventory builds and a general lack of buying interest. We believe we are close to the end of the inventory build cycle and expect to see volume and pricing improvements in the coming years. The last several quarters have seen sequentially-improving year-over-year earnings growth at Rocky Mountain, and the pattern of positive earnings surprises suggests the analyst community is behind the curve on the industry. In addition, we expect Rocky Mountain to benefit from strong operating leverage when activity picks up, which will further drive the company’s per share growth in earnings. At the current valuation of 8.5x forward earnings and 5.5x forward EBITDA, we like the positon for an entry here and see attractive risk-reward. We haven’t modeled any acquisitions into our analysis but see the likelihood of this type of catalyst as high given owner demographics and an activity rebound that should spur an uptick in consolidation.

HORIZON NORTH LOGISTICS (HNL.TO)
Horizon North provides remote accommodation and related services to the workers and executives of energy companies in Western Canada. In addition, they have recently increased their focus on permanent modular, which we believe offers a diversified revenue stream that is not currently built into estimates. While it has been a challenging couple of years for this industry as competition has created a tough pricing environment, we believe the companies with the strongest balance sheet will be in the best position to consolidate the industry and thrive in the coming years. Given that Horizon North raised $50 million of new equity capital in June 2015 at $3.75 (currently trades at $2.00) and the fact that a couple of their lodges were lost to the Fort McMurray fires, creating large insurance proceeds (estimated at around $25-$30 million), we believe Horizon North fits the bill. In fact, we have already seen activity on the consolidation front as Horizon North has purchased Empire Camps Ltd, a major competitor, along with Karoleena, a designer of prefab homes. With a well-covered dividend yielding 3.9 per cent and a trough valuation of only 7x EBITDA, we see Horizon North as a very compelling opportunity to take advantage of the recent resurgence of activity in Western Canada (pipelines and rigs) and the rebound in the oil price.

MTY FOODS (MTY.TO)
MTY Foods operates as a franchiser of quick-serve restaurants and has grown quite impressively over the past 30+ years adding multiple new banners, geographies and opportunities along the way. Their largest acquisition to date occurred last year with the purchase of Kahala Brands for US$310 million which provided a solid platform in the U.S., further diversified their brands and allowed for the deployment of existing concepts into new markets. While the valuation of this business is high relative to our universe of investable ideas, we believe it deserves the premium multiple (12x EV/EBITDA) given an excellent record of capital allocation, acquisition discipline and very strong profitability. While the current dividend yield is only 0.95 per cent, their low payout ratio and high free cash generation puts this company high on our list of companies with the capacity to increase dividends over the coming quarters.