Jan 24, 2018

Jennifer Radman's Top Picks: January 24, 2018

BNN Bloomberg

Jennifer Radman , BNN

Jennifer Radman, vice president and senior portfolio manager at Caldwell Investment Management
FOCUS: U.S. large caps
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MARKET OUTLOOK

One of the more interesting things about 2017 was the apparent shift in investor psychology. Up until the latter part of the year, fear (is this the top? are we headed for another crash?) and disbelief/skepticism (how can markets make new highs with Brexit and Trump?) seemed to dominate investor thinking. As markets continued to reach new highs, however, ‘fear of loss’ seemed to shift to ‘fear of missing out.’ It has once again become exciting for people to talk about the markets and the amount of questions, and the money being thrown at unproven business models in digital currencies and marijuana is telling.

While these are signs that the market is closer to a top than a bottom – we buy into the ‘cycle of emotion’ where market bottoms coincide with extreme fear, while tops come with extreme exuberance – predicting the timing of when the top will occur is anyone’s guess. This creates difficulty, given that we live in a world where performance returns are published on a daily basis. Most pundits expected higher volatility in 2017 (an erroneous forecast). That forecast has now shifted into 2018. Our recommendation to investors is to have a conversation with their investment advisors on cash needs. If money is required in the next year or two, it may be wise to lock in some gains.

TOP PICKS

Stantec (STN.TO)
Stantec is the third-largest design firm in North America and provides engineering, architecture, and project management services to infrastructure (28 per cent of revenue), buildings (22 per cent), water (22 per cent), environmental services (17 per cent) and energy and resources (11 per cent) projects. STN has 22,000 employees and operates in 400+ locations globally. This is a high-quality business that has underperformed peers on the back of oil and gas/resource exposure and several self-inflicted, but temporary (in our view) missteps. We believe these issues are behind the company and several catalysts suggest a higher share price going forward, including: 1) analyst estimates have been re-set lower, thereby reducing the likelihood of additional disappointments, 2) infrastructure spending is picking up and STN should benefit given its leadership positions in key verticals, 3) commodity prices have moved higher suggesting STN’s commodity-related verticals have likely seen a bottom, 4) a new CEO helps put recent missteps in the rear view mirror, 5) renewed M&A after an extended integration period. At the time of purchase, STN traded at a 5.2 per cent FCF yield versus 4.6 per cent and 3.0 per cent, respectively for peers TTEK and WSP despite significantly higher ROE’s. Versus our broader screening universe, STN has a higher ROE, better balance sheet, lower capex requirements, greater profitability, equal to or greater growth opportunity and yet trades at over 2x the universe's FCF yield at 5.2 per cent.

Delphi Technologies (DLPH.N)
A recent spin-out from Delphi Automotive, it is a leader in products that optimize a vehicle’s powertrain. It is a best-in-class operator with a long track record of consistent execution and solid market share positioning in each of its major segments. Delphi has strong relationships with most of the major OEMs and, given its high degree of technical expertise, benefits from high switching costs. The company is well-positioned to benefit from: 1) regulatory-driven reductions in vehicle emissions, 2) the shift from combustion to hybrid/electric-vehicle (EV) systems (where Delphi carries 5x the normal engine content), and 3) a cyclical recovery in commercial truck/aftermarket volumes. We believe these growth opportunities, coupled with margin expansion and a multiple re-rate to reflect its status as a beneficiary of EV systems, will drive the stock price meaningfully higher.

Berry Global Group (BERY.N)
Berry is a leading specialty plastics producer whose products are used in a diverse set of end markets, including the health and personal care, household, food and beverage, food service, industrial and transportation markets. It is a leader in the fragmented specialty plastics industry where its scale allows it to be the low cost producer. With US$7B in revenue within a US$200+ packaging industry, the company has continued growth runway through a successful M&A strategy that has resulted in meaningful EPS growth. With approximately two thirds of revenue tied to stable end markets, we expect BERY to provide stability to the portfolio. From a valuation standpoint, we view BERY's five per cent free cash flow yield, which ranks in the top 15 per cent of our screening universe, as attractive.