Jason Mann, CIO and co-founder of EdgeHill Partners

Focus: North American equities
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MARKET OUTLOOK
2016 was full of surprises with unexpected market reactions to events like Brexit and Trump and the start of a major regime shift from defensive bond-proxy stocks to cyclical value stocks.

We think that we are only half way through the “value” trade that began in the spring of last year, accelerated in the summer and was punctuated by the U.S. election.

Whereas last year was about owning cheap stocks that didn’t go bankrupt (low price-to-book with too much debt), we think as the cyclical value trade rolls on that you now want to focus on quality value stocks: cheap price-to-cash-flow, high return-on-equity, reasonable balance sheets.

We think that despite the more recent check-back of the “Trump trade,” it is too early to call an end to it. Expect: reflation and earnings growth, rising interest rates, cyclical value stocks leading the market higher, and bonds and defensive stocks as laggards.

It’s not just the U.S. leading growth higher; Europe is now showing all the signs of and improved macro outlook despite the political challenges. Emerging markets are strong, as well, despite a higher U.S. dollar.

We are underweight growth stocks (high valuation stocks). Growth works when growth is scarce like it was in the last few years. When the economy grows, focus on cheap stocks.

Underweight safety, defensive, and “bond-proxy” stocks. For yield stick with banks, insurance, industrials, discretionary where they can grow the dividend.

The move to an inflationary environment should be viewed as late-cycle, and we think we are in the "seventh-inning stretch" of this bull cycle, but that we could have another 12 to 18 months of this environment.

TOP PICKS

CHORUS AVIATION (CHR.TO)

• An airline stock without the typical sensitivities to fuel costs, traffic, currency, etc. — basically a “pass-through” contract operator for Air Canada
• A while back won an arbitration with Air Canada (their only customer) on the rates they charge that keeps their current contact prices in place to 2025
• They are tied to the health of the airline sector in general in terms of volumes and specifically tied to the health of Air Canada. Air Canada itself is a cheap stock and their business has been improving
• They are good operators and the stock remains in the top decile for valuation for us: has been averaging 40 per cent ROEs and is currently 6.4x 2018 EV/EBITDA, 8x PE. They yield 6.5 per cent with only a 50 per cent payout ratio, so lots of buffer on the dividend. Also scores well for us in terms of its strong price momentum and low volatility
• What makes it more interesting and worth re-highlighting is that one of the knocks against them has been no path to growth. They now have one in the form of a new “full service” (aircraft transition, fleet inspection, part support, training, etc.) aircraft leasing business which was funded by Fairfax with $200 million. Adds a growth business for them that is estimated to add $0.50 to 1.00/share in value for them on base case, and as much as $6.00/share blue sky on some estimates.

BRP INC. (BOMBARDIER RECREATIONAL PRODUCTS) (DOO.TO)

• This is the spin-off from Bombardier and they are the makers of Ski-Doo, Sea-Doo, ATVs, and other personal recreation vehicles
• Fits the theme of strong consumer sentiment and job growth — their products are a direct beneficiary of that
• Stock is cheap — scores in top five per cent for us on that measure, at 10x PE, 8.6x EV/EBITDA, under-levered balance sheet
• Recently beat on earnings and put out what might prove to be conservative guidance; has moved the stock higher but now has improving price momentum, as well
• It is a growth story at a reasonable price, with improving margins and good management
• Artic Cat (competitor) was acquired this month at 13.6X EBITDA, equivalent to a 60 to 80 per cent premium if applied to DOO share price

MARTINREA (MRE.TO)

• Martinrea is the “other” Canadian auto-parts maker — Magna and Linamar perhaps better known, and we like both of those, as well
• Specialized in metal parts, metal bending, as well as fluid systems, tubing, tooling, etc.
• Like most of the parts-makers, stock is perpetually cheap, and it scores in the top five per cent for us on relative valuation
• Trades at only 5.1x EV/EBITDA, 1x book, 6.5x PE with 16 per cent ROEs. One of the risks is a bit of a stretched balance sheet, but therefore has more torque to an improving business
• Price momentum is improving as well — despite the risk to all of these parts makers of a border adjustment tax (i.e. tariffs)
• They have been in “turnaround” mode for a while, with the goal of improving margins and completing acquisitions  — an opportunity to improve cash-flow from the current asset base and get a re-rate versus peers
   

PAST PICKS: APRIL 6, 2016

TURQUOISE HILL RESOURCES (TRQ.TO)

• Then: $3.30
• Now: $4.17
• Return: +26.36%
• TR: +26.36%

WESTSHORE TERMINALS (WTE.TO)

• Then: $16.75
• Now: $26.11
• Return: +55.88%
• TR: +60.26%

TRANSALTA (TA.TO)

• Then: $5.87
• Now: $7.76
• Return: +32.19%
• TR: +35.44%

TOTAL RETURN AVERAGE: +40.68%
 

FUND PROFILE: EHP SELECT FUND

PERFORMANCE AS OF MARCH 29, 2017:

• 1 month: Fund 2.5%, Index* 1.6%
• 1 year: Fund 14.0%, Index* 19.5%
• Since inception (November 2014): Fund 15.3%, Index* 5.3%

* Index: SPTSX Total Return (assumes reinvested dividends)
* Fund’s returns assume reinvested dividends

TOP HOLDINGS AND WEIGHTINGS

1. Canadian National Railway: 5.2%
2. Dollarama: 5.2%
3. Interfor: 5.1%
4. Industrial Alliance Insurance: 5.0%
5. West Fraser Timber: 4.9%

WEBSITE: www.ehpfunds.com