Oct 6, 2017

John Zechner's Top Picks: October 6, 2017

BNN Bloomberg

John Zechner, chairman and founder, J. Zechner Associates , BNN

John Zechner, chairman and founder of J. Zechner Associates
Focus: North American Large Caps
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MARKET OUTLOOK

Stocks have rallied to new highs on optimism that the Trump presidency will lead to higher U.S. and global growth, reduced regulations, higher infrastructure spending and drastically reduced taxes. Though they have thus far failed to deliver on those promises, investors have given them the benefit of the doubt and continue to push stocks higher. Stronger economic growth in Europe and Japan have also supported that bullishness. But we remain skeptical on the outlook for stocks as valuations remain high, interest rates are rising and we expect earnings growth to slow down. The bottom line is that the risk/reward ratio for stocks is unfavourable in our view and we continue to structure our managed funds accordingly. While we don’t want to infer that ‘the sky is falling’ in terms of financial markets, we can’t help but be aware of the risks that have been created by an extended period of excessively low global interest rates. Money has flowed to the riskiest assets and investors have become complacent about the risk that this entails, not unlike the way funds flowed excessively to the U.S. housing market from 2003-2007 and then into commodities from 2008-2011. In both cases, the markets collapsed once the funds flow started to reverse. Central banks are now in the process of unwinding the massive pools of liquidity that have fueled the bull market in financial assets. While global economic growth has surpassed our expectations this year and the optimism around the potential ‘Trump Agenda’ has fueled more optimism about better U.S. growth, we are very late in the economic cycle and capacity is getting strained in many sectors, including the labour market. Rising wages will keep the U.S. Fed tightening monetary conditions. While no one can accurately predict the timing of any such event, we have to believe that the risks are higher for stocks than they have been since 2011, when we had our last significant market correction.

TOP PICKS

TRINIDAD DRILLING (TDG.TO) - Last purchase $1.60, Aug. 2017
Don’t have to be an energy bull to like Trinidad here. While rig count has been flat recently, they have been shifting rigs to US (Permian Basin) from Canada and making ‘tuck-in’ acquisitions to round out/expand product offering. All of this should improve margins and growth. Also still has joint venture with Haliburton for foreign drilling rigs. Rising free cash flow has been used to reduce debt to much more manageable level. Best reason though is that the stock is trading at about 35% of the replacement value of their assets which, in the past, has always been the low point for energy services companies

MAXAR TECHNOLOGIES (MAXR.TO) - Formerly MACDONALD DETTWILER (MDA.TO) - Last purchase $66.00 Aug. 2017
With closing of DigitalGlobe (DGI) acquisition, Maxar is set for new round of growth at a valuation discount to aerospace peers. DGI provides Maxar with increased exposure to the data and services part of satellite earth observation market, which has higher growth than their traditional satellite manufacturing business. It also gives them better U.S. market access and therefore more exposure to growing US government spending in this area. Strong free cash flow generation will allow them to pay down acquisition debt relatively quickly. Valuation reasonable at about 12 times forward earnings and 8 times forward EV/EBITDA. We should also see increased interest from US investors.

OPEN TEXT (OTEX.TO) - Last purchase $39.00 Sept. 2017
Company has done excellent transition over past five years from licence-based document management software company to cloud-based EIM (Enterprise Information Management) company by making numerous strategic acquisitions (recent ones include Magellan and Documentum) and strategic marketing partnerships with the like of SAP, CapGemini, Accenture and CGI. Strong free cash flow has allowed the company to quickly pay down acquisition debts as well as increasing the profit margins of the acquired businesses. Recurring revenue base from cloud-based businesses should also allow the company to get a higher valuation, which remains low at only about 13 times forward EPS and 10 times forward EV/EBITDA. ‘Blue sky’ upside could come from AI (artificial intelligence) capabilities on either a stand-alone or integrated basis coming from recent Magellan acquisition.