Full episode: Market Call Tonight for Tuesday, May 7, 2019
James Telfser, managing partner and portfolio manager at Aventine Asset Management
Focus: Canadian equities
We believe the current investing environment is more balanced from a risk/return standpoint versus a couple months ago. While financial conditions, breadth and credit metrics have all improved and many recent geopolitical risks have receded, we’re more cautious about valuations at current market levels. We’ve raised a modest amount of cash in our accounts to take advantage of any dislocations to the seemingly “perfect” narrative. Furthermore, we’ve been taking advantage of the dramatic reduction in volatility by selectively adding downside protection where appropriate. However, given the bottoming of some global economic data as well as stronger-than-expected corporate profits in the first quarter of the year, we remain positively biased from an asset allocation perspective.
Our private client accounts took advantage of the selloff towards the end of last year by adding to equity positions from our core Canadian and U.S. Compounders Strategy. We’ve also been taking advantage of the weakness in the Canadian preferred share market as we believe a number of issues are now deeply oversold from the back up in interest rate expectations. Lastly, we added some opportunistic credit exposure and private equity to accounts as we believe returns here will continue to outpace simple asset allocation models. Overall, we continue to stress patience. We’ve been adding several great businesses to our watch list and are waiting for volatility to pick up again to get more aggressive as valuations reach our entry levels.
Emera offers a compelling combination of growth and defence. The team here has executed exceptionally well over the years and has clearly demonstrated that they’re good stewards of our investors’ capital. We’d expect gains here to come from a combination of organic growth, dividend growth and valuation expansion. Emera is taking $2 billion in proceeds from the sale of their Maine operations and New England gas generation plant to immediately deleverage, but has a plan on investing $6.5 billion into the business over the next three years, half of which will be in Florida, a state with a terrific 6 per cent annual rate growth based on population dynamics and one that allows for high ROEs vis-à-vis other states. Interest rates globally remain depressed, which bodes well for the valuation of utilities and other interest rate sensitive sectors. Emera is trading at 17 times expected earnings and has a dividend yield of 4.7 per cent. This comes with 95 per cent of their asset base being regulated or very predictable. Management recently reiterated their target for 6 to 7 per cent earnings growth and 4 to 5 per cent dividend growth.
OPEN TEXT (OTEX.TO)
Open Text is a solid long-term investment with mid-single digit organic growth, substantial free cash flow growth and catalyst potential through acquisitions ($6 billion spent on 30 acquisitions in the last 10 years). Open Text trades at a significant discount to peers in the software space (11 times EBITDA versus peers at 17 to 18 times). While this discount has been driven by “lumpy” quarterly results over the years, we’ve noticed a change in management focus towards consistency, return on capital and organic growth which will help close this gap. We like the fact that annual recurring revenue makes up 75 per cent of total revenue, including cloud-based services which in the recent quarter were up 14 per cent year-over-year. We also like that the business model of Open Text drives significant free cash flow, which helps drive the M&A cycle. If you think in years versus quarters with Open Text, we believe you will be rewarded with strong shareholder returns that will likely outpace the major indexes.
CCL INDUSTRIES (CCLb.TO)
CCL has been a great holding for us over the years, but after watching the valuation for this label manufacturer fall from a peak of 27 time price-to-earnings in 2016 to its current level in the high teens, we believe it’s time to start revisiting the name. They’ve struggled over the last few quarters along with most packaging companies, as increasing resin prices and the general economic slowdown impacted their growth trajectory as well as margins. Despite the short-term hiccups, it’s important to recognize that CCL is a best-in-class company with a strong management team and excellent prospects for both organic growth and acquisitions. CCL has done an exceptional job buying competitors and businesses operating in similar industries and helping them bring more “best manufacturing practices” to their operations while still encouraging and regarding local decision-making. At the current valuation at 19 times this year’s earnings, coupled with a strong balance sheet (1 time net debt to EBTIDA), we believe investors will be rewarded as the company executes going forward.
PAST PICKS: OCTOBER 9, 2018
DESCARTES SYSTEMS (DSG.TO)
- Then: $40.24
- Now: $54.29
- Return: 35%
- Total return: 35%
BROOKFIELD ASSET MANAGEMENT (BAMa.TO)
- Then: $56.13
- Now: $63.41
- Return: 13%
- Total return: 14%
PREMIUM BRANDS HOLDINGS (PBH.TO)
- Then: $90.03
- Now: $80.65
- Return: -10%
- Total return: -9%
Total return average: 13%