John Zechner's Top Picks: November 16, 2016

John Zechner, chairman and founder at J Zechner Associates

Focus: North American large caps
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MARKET OUTLOOK
We don’t believe that the recent ‘Trump stock market rally’, which has been based on positive views of massive infrastructure spending and reduced regulation, will persist. Promised $1 trillion fiscal infrastructure spending is large but is only 5 per cent of annual U.S. GDP and will be spent over 10 years so the annual economic impact is <0.5 per cent.  While U.S. banks and industrial stocks have rallied, emerging markets have fallen over 5 per cent on worries about the stronger U.S. dollar and tougher trade negotiations. China and Saudi Arabia have already suggested retaliatory measures if proposed import tariffs/restrictions are implemented. The recent rise in the U.S. dollar will negatively impact profits of U.S. multinationals and is also a negative for commodity prices, one reason why Canadian stock gains have lagged those of U.S. Stocks still trading near record valuations but are losing support from interest-rate comparisons as rates rise on fears of higher inflation. Trump ‘tough on trade’ and ‘return to growth’ election promises will be hard to realize. Globalization has reduced manufacturing costs and expanded markets for many firms in consumer products, industrials and technology over the last decades and those gains are at risk if global trade deals and immigration are threatened and companies are forced to move manufacturing back to the U.S. where costs are higher, productivity is lower and the work force is older and not growing. Higher interest rates will lessen the ‘TINA’ arguments for stocks as they provide safer, more attractive alternative. We have seen bear markets in stocks early in most presidencies. While initial reaction has been extremely bullish, we now see greater risks to global economic growth at a time when earnings growth is negligible and stock valuations are high. Market breadth has narrowed and key leadership sectors have also broken down, another warning sign. We are cautious on the outlook for stocks and are reducing positions in the energy and materials sectors. Technology stocks have been under short term pressure but we still see growth in the sector longer-term at reasonable valuations and look to add to this group first. Financials will also benefit from a ‘normalization’ of interest rates.

TOP PICKS

SHORT: CATERPILLAR INC (CAT.N) 
Stock trading at over 30 times earnings despite missing estimates and guiding lower again. Little growth expected in 2017 as global capex/mining spending is slowing and there is a glut of equipment on the market; CAT has started selling their own used equipment on their website and prices have been falling at 5 per cent annual rate. Investors are far too optimistic about impact of U.S. infrastructure spending for CAT. Stronger U.S. dollar is also a headwind.  Multiple on 2017 earnings higher than that of Facebook which seems like a disconnect, given such differing growth rates. More conservative strategy would be to hedge this short sale trade with an offsetting long position in a more reasonable priced industrial stock such as CP Rail.

MARTINREA INTERNATIONAL (MRE.TO)
The stock is trading at lowest valuation of group but expecting >10 per cent earnings growth per year over next three years, as recent spending to roll out new programs yield results. Profit margins expanding as these new growth platforms are more fully utilized and margins continue to rise. Excess cash generation is also being used to reduce financial leverage significantly. Martinrea also has best exposure in the industry to the increasing use of aluminum in autos, which is a substantial ongoing trend to lower overall production costs and operating efficiencies. Sector valuations exceptionally low (already pricing in the next recession) as investors are worried about ‘peak auto’ sales as well as negative impact from Trump threats to force auto companies/suppliers to move production back to the U.S. Average age of autos in North America remains near a record high and auto spending is tied to growing employment levels, suggesting less of a downturn than investors are worrying about.

DHX MEDIA (DHXb.TO)
World’s leading independent, pure-play kids’ content company and animation house. DHX trades at an Enterprise Value/EBITDA multiple of under 10 times, a significant discount to industry comps and recent corporate transactions. Q1/17 results show a ramp to secular growth on the financial contribution from new international partnerships (DreamWorks Animation, Mattel, Iconix) as well as an improving ability to convert EBITDA to free cash flow as program capital spending needs decrease. Benefitting from the migration to digital platforms; 85 per cent of their distribution revenue comes from digital sources. Also has Global distribution to 300+ broadcasters and streaming services worldwide including their Family suite of channels in Canada and a growing roster of high-profile brands to drive increasing merchandising revenue. Growth at WildBrain, a multi-platform kids’ network is also exceeding expectations. Content continues to be a key asset in media and we see the stock as a Canadian ‘mini-Disney’ as it develops kids content and then cross-markets it through a growing array of distribution channels.
 

PAST PICKS:  NOVEMBER 3, 2015

HUDSON’S BAY COMPANY (HBC.TO)  

• Then: $22.85
• Now: $14.61
• Return: -36.06%
• TR: -35.30%

APPLE (AAPL.O)

• Then: $122.57
• Now: $109.99
• Return: -10.26%
• TR: -7.87%

CONCORDIA HEALTHCARE (CXR.TO)

• Then: $37.14
• Now: $4.32
• Return: -88.36%
• TR: -88.26%

TOTAL RETURN AVERAGE: -43.81%

* J. Zechner Associates has had a ‘no trading policy’ in place since firm inception in 1993 so the money managers aren’t allowed to have personal or family positions in any stocks unless within the context of a Managed Fund.

FUND PROFILE: J ZECHNER GLOBAL HEDGED GROWTH FUND

PERFORMANCE AS OF: OCTOBER 31, 2016

• 1 month: Fund 1.37%, Index* -0.86%
• 1 year: Fund 25.22%, Index* 4.24%
• 3 year: Fund 13.13%, Index* 4.06%

* Index: GlobeFund Alternative Strategies Index
* Net of fees

TOP HOLDINGS AND WEIGHTINGS

1. SHORT: SPDR Trust Unit (SPY): 61.3%
2. SHORT: Caterpillar Inc. (CAT): 16.3%
3. SHORT: Encana Corp (ECA.TO): 9.0%
4. SHORT: iShares Biotech (IBB): 9.0%
5. LONG: Detour Gold (DGC.TO): 4.4%

TWITTER: @johnzechner
WEBSITE: www.jzechner.com