Kevin Burkett, portfolio manager at Burkett Asset Management

FOCUS: Canadian large cap stocks

MARKET OUTLOOK:

Markets performed strongly since last summer, responding to improving pandemic headlines in anticipatory fashion. Investors now wonder if the aggressive monetary response was too much. A concerning recent acceleration in inflation measures fuel this concern. Our research team has focused on positioning portfolios to perform strongly for a return to normal, a task that begins with a consideration of how “normal” will look after all that happened in the past 14 months.

While we resist the urge to guess where we are in the economic cycle, today’s macro-environment tempts us to try. Our house view is aggressive action by central banks “kicked the can” down an untested road on the monetary side and the political nature of fiscal policy decisions looks sure to take us further along this road. We worry market participants may under-estimate the impact pro-longed inflationary pressures (or equally important, fear of these pressures) have on securities pricing, broadly.

As to securities themselves, the technology sector is in clear-cut overvaluation territory, whereas value-oriented sectors reflect a more balanced view of mounting risks and dwindling further rewards. We have a current preference for financials, resources, and those industrial-industry businesses positioned within supply chains to pass price increases along to customers. These are all well represented sectors here in Canada.

Where traditional models for asset prices place heavy emphasis on risk free rate, our firm thinks about intrinsic value in a continuum; what is the marginal expected return per unit of risk. Where risk free rates increase, so do investors’ expectation for returns, requiring securities prices to fall. This guides our belief that near-zero policy rates reflect the precarious nature of markets today, not justifications for higher security prices.

This is a market that demands caution.

MID-SHOW CHAT:

Brief background on me:

My family business was accounting – I grew up around professional services. I remember being 10 or 12 and watching BNN in the lunchroom at Deloitte’s Victoria office, waiting for my dad to finish work.

I then became a chartered accountant, moving into investment banking with Scotia Capital and later Credit Suisse in Calgary and London. This was an exciting time doing large corporate deals/transactions, issuing different security types for mostly energy issuers.

In 2013, I returned home to join dad in our accounting practice. There were four or five of us. I was surprised at the varied experience customers were having with investments, and engaged in conversations on what they felt they were missing. I used those conversations as blueprint to start my own, totally independent, investment firm. I registered with BCSC in 2015 and by 2016 I was managing more than $100 million.

Since then, we have managed to continue to attract inflows and deliver strong performance. We now employ five people at our investment firm and around fourteen at our accounting practice. Our firm did a survey recently and found 96 per cent of clients would recommend us to their friends.

During my last appearance on BNN on February 24th, I picked three stocks. Here’s how they’re performing now:

Tourmaline - $23.92 – Feb 24th, closed at $28.37 May 25th = +18.6 per cent price return, total return of 19.4%

First Capital - $15.82 – Feb 24th, closed at $17.51 May 25th = +10.7% price return, total return of 11.4 per cent

Winpak - $39.46 – Feb 24th, closed at $39.46 May 25th = +2.3 per cent price return, total return of 2.4 per cent

This would mean on an equal-weighted basket of my three picks, your portfolio would be up 11.1 per cent, which would put you about five per cent ahead of the S&P TSX in same period.

TOP PICKS:

CN Rail (CNR TSX)

CN had been at nearly 150 before the Kansas City Southern deal sank shares lower. We categorize this as a special situation, given the KSU (Kansas City Southern) transaction. I see this as a window of opportunity to a acquire shares in our favourite stock in Canada. The board of KSU favored the CN deal over that offered by CP Rail. My take: if KSU fails – it’s a win. If KSU succeeds, then they blocked CP and now have a leg into Mexico. CN is a rail footprint, an irreplaceable asset base, which also makes sense for ESG- rail is the most efficient way to transport goods. I prefer CN to CP because I consider the assets higher quality and prefer management.

Toromont Industries (TIH TSX)

Our firm likes heavy equipment dealers - we see them as lower risk than say, an auctioneer like Ritchie Bro’s. I’ve traded between Finning International and Toromont, thinking of them as similar businesses. They are not. Finning’s management team just can’t seem to catch a break. At least some is self-inflicted their ERP system snafu led to some massive inventory backlogs. Toromont also has virtually no debt, which Finning carries 1.5x. Toromont’s team is first-class; Scott Medhurst has delivered beat after beat, oftentimes by a wide margin. They have a record backlog (almost $1B). Toromont is exposed to construction, power systems, and agricultural end users. What’s not to love? The return on invested capital is in the mid-teens, with wide gross margins (~25 per cent).

Telus (T TSX)

This is also a bit of a special situation, with ongoing consolidation of telecoms in the Rogers/Shaw deal. I see Telus as the winner, from the periphery. Raised $1.3 billion to accelerate capex. Where a company buys another company in a mature industry and a competitor raises money to double down on itself, that’s where I want my money. Darren Entwisle is extremely capable on execution. My only criticism might be how much he is paid, with total compensation at $16 million. I like his angle, playing vertically adjacent businesses and considered the Telus International spin-out clever and value creating.

Company Website:  www.burkettassetmanagement.ca