Nov 28, 2018

Jason Mann's Top Picks: Nov. 28, 2018

BNN Bloomberg

Jason Mann , BNN Bloomberg

Jason Mann, partner and chief investment officer at EdgeHill Partners
Focus: North American equities

MARKET OUTLOOK

U.S. market strength, which had been holding up versus the rest of world, finally cracked in October. There’s still catch-up to the downside for the U.S. market to move more in line with global markets. We’ve been a broken record, warning about the over-valuation of growth stocks such as cannabis and the FAANGs.

Up until recently, this growth-at-any--price trade has led to underperformance of higher-quality, more profitable stocks, while money had been deployed into ever more expensive growth stocks, in many cases without any earnings. October was the end of the growth outperformance for this cycle in our view and we’re now seeing sector and style rotation to quality, dividend-paying, lower-volatility stocks. There are many months ahead of us for this rotation to continue if we are correct. The drop from growth to value for a stock can be a long way down.

Global growth appears to have peaked, with Germany and Japan actually posting negative GDP quarter. U.S. earnings remain strong, but the rate of change is slowing and we expect margins to be pressured in coming quarters. Is this just a growth pause or a growth rollover? It’s too early to tell.

The other big question is whether the U.S. Fed will take a pause after a December rate hike. If so, the long-end of the curve should move lower, and the defensive U.S. 30-year treasury bonds, which are historically used as a flight-to-safety asset, should do well.

We’re playing defense in our funds after having reduced risk across the board in our portfolios over the last few months, and if nothing else, we expect this volatility to last for a number of additional months.

TOP PICKS

GEORGE WESTON (WN.TO)

We are playing defense here, and looking for undervalued stocks in the “stable, profitable business” category. Weston fits this bill nicely. Business is 3 parts – Weston foods which is their core bakery business, a 50 per cent stake in Loblaws, and they recently absorbed Loblaws’ holding in Choice Properties, which is the REIT that owns Loblaws’ real estate. It has two main characteristics we like: reasonable valuation and a very stable stock price. On valuation, it scores in the top 25 per cent of companies for us at 8.5 times price to free cash flow (P/FCF), 9.7 times enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA).

As a part of their recent reorganization, Loblaws shareholders received shares in George Weston that they appear to have been selling down. As a result, the company now trades at a 13 per cent discount to its sum-of-the-parts, which is an historically wide discount. While there is nothing that says that discount needs to collapse, there is enough of a “catch-up” opportunity for George Weston relative to Loblaws and Choice Properties REIT that we think it’s a buy here.

GREAT-WEST LIFECO (GWO.TO)

Great West is in the life insurance and asset management business, and is majority held by Power Corp. It’s an example of a defensive business that can provide a safer place to invest. We like it on valuation – scores in top 25 per cent of companies, with high return on equity at 20.5 per cent, price-to-earnings of 7.2, yield of 5.1 per cent that is sustainable. Trades at 1.4 times book value, which is at the low end of its historical range (30-year-average is around 2.25 times book). It is also a very stable stock and it scores in the top 3 per cent for us on this measure.

Price momentum is the only knock against this stock as it scores in the middle of the pack. However, if we are in a rising interest rate environment that persists, insurance companies historically benefit. Another downfall is that is has historically traded at a premium to peers, and to justify that, they need to show that they can deploy excess capital into growth initiatives. They are well positioned to do that and the market may provide them with such opportunities.

AECON (ARE.TO)

Aecon might be a more controversial pick in this context given that it is a cyclical construction business and recently came through a failed takeover by a Chinese company. The backstory is that Aecon put itself up for sale in the summer of 2017, ultimately got a bid from a Chinese company about a year ago, and then that deal was blocked by the Canadian government on “national security” concerns. They have a new CEO as a result.

It’s hard to tell whether the decision to block the deal was politically motivated, but ultimately it doesn’t matter and we need to assess Aecon as it is today. By that measure, Aecon is cheap at current prices despite its price recovery off the lows of the failed deal. It scores in the top 2 per cent of companies in terms of value at 2.2 times P/FCF, 6.7 times EV/EBITDA.

The balance sheet is solid with no meaningful net debt, and they pay a modest 2.7 per cent yield. Backlog is the real story though. They have a $7 billion backlog and are bidding on $50 billion worth of projects. Margins on these mega-projects are strong. Price momentum is strong as well: It scores in the top 10 per cent of companies on this measure.