Kim Bolton's Top Picks: February 2, 2022

MARKET OUTLOOK:

For a while now, your BSD team believed equity markets seemed to be heading for a “perfect storm” of rising interest rates, shrinking liquidity, escalating inflation, supply chain constraints and rich valuations. 

Through December and into the new year, our BSD Global Tech Hedge Fund’s stock portfolio was near fully invested, with an overweight short equity index hedge on the notional value of the stock portfolio that would incrementally grow (from the laddered Nasdaq put options strategy) if/when the stock market would deteriorate from this “perfect storm”.

Really, the market has been talking about supply chains for about two years now and equities have managed to trade higher. U.S. CPI has been above 5 per cent since last May and the market has managed to trade higher. 

Russia/Ukraine is definitely dampening sentiment (especially in Europe) but the big change is the U.S. Fed - a more hawkish sounding Powell and the prospect of more/faster rate hikes. The markets have been able to overcome a lot of obstacles in the last few years but the removal of accommodation by the Fed is the toughest one of all. 

We are sure the markets will still need to go through more of an adjustment period and expect stock markets to continue to churn and volatility to remain high for the near future. For now, the stock markets are looking at things with a glass half empty approach, meaning it will take a while longer to shake off the negative sentiment.

At the time of writing this commentary (on the first trading day of February), your BSD Global Tech Hedge is up 0.50 per cent year-to-date, while our 50/50 Nasdaq/Russell benchmark is down 10 per cent, and the S&P 500 is lower by 6 per cent.

TOP PICKS:

Texas Instruments (TXN NASD)
Texas Instruments Incorporated designs, manufactures, and sells semiconductors to electronics designers and manufacturers worldwide. It operates in two segments, analog and embedded processing. 

The analog segment offers power products to manage power requirements in various levels using battery management solutions, DC/DC switching regulators, AC/DC and isolated controllers and converters, power switches, linear regulators, voltage supervisors, voltage references, and lighting products. 

The embedded processing segment offers connected microcontrollers, such as microcontrollers, microcontrollers with integrated wireless capabilities, and stand-alone wireless connectivity solutions that are used in electronic equipment; digital signal processors for mathematical computations; and applications processors for specific computing activity. 

This segment offers products for use in various markets, such as industrial, automotive, personal electronics, communications equipment, enterprise systems, and calculators and other. 

Revenue beat: TI executed well in the quarter delivering 9 per cent upside to 4Q21 Street revenue expectations. Management cited strength across all major end-markets, device types, and geographies. On a yoy basis, Enterprise Systems (+50 per cent yoy, albeit off a depressed base) -- driven by strength in data center and enterprise compute -- and Industrial (+40 per cent yoy) were the stand-outs. 

Management stated that orders were strong in the quarter and that lead times remain stable. 

Additionally, TI -- similar to 3 months ago -- noted that customer expedites have been limited to specific 'hot spots'. Record high gross margin: 4Q21 gross margin of 69.3 per cent (+140bps qoq, +440bps yoy) exceeded Street expectations by 220bps and marked an all-time high for the company. This improvement illustrates TI's robust operating model and the benefits stemming from its gradual transition from 200mm to 300mm manufacturing.

Shopify (SHOP TSX)
SHOP provides ‘e-commerce as a service,’ primarily to small- to medium-sized businesses in over 175 countries. The company’s platform is used by customers to set up both the e-commerce front end (web, mobile and social media) as well as to set up back end infrastructure that helps customers manage inventory, orders, payment, shipment, working capital financing and data analytics. 

Given the very long runway for the continuing global secular shift to online retail, combined with the stickiness of the business (the platform is irreplaceable to many SMBs), and the company’s track record of innovation (current subscription and merchant solutions are expected to grow at greater than 25-30 per cent over the next 5 years, more ammunition in fulfillment and international opportunities), we see a dramatically higher price share.

“Shopify’s tremendous third-quarter results reflect the resilience and entrepreneurial spirit of our merchants,” said Amy Shapero, Shopify’s CFO. “More entrepreneurs are signing on to Shopify so they can quickly and easily put their ideas into action. We continue to evolve our global commerce operating system to make it easier for merchants to get online and start selling, get discovered, and get their goods to buyers, while providing a delightful shopping experience.” 

They are reaping the benefits of their 2019 acquisition of 6 River Systems (fulfillment and shipping solutions) as they reported that over 50 per cent of eligible merchants in US and Canada are using Shopify Shipping. Shopify’s point of sale (POS) solution “Shop Pay” partnered with Facebook to offer their solution on the Instagram and Facebook platforms.

 
Constellation Software (CSU TSX)
The company's business strategy is to acquire software startups, and then hold them for the long term. It has acquired over 260 startups since being founded. It focuses on vertical market software companies (i.e. those that create software for a particular industry or market, as opposed to creating software usable for a wide variety of markets) The company has a 10-year average ROIC of 32 per cent. 

Competition is increasing, but overpaying for companies makes it hard for them to sustainably generate profits. The ability to scale across different verticals remains one of its key moats. Their growth over the years is heavily dependent on acquisitions, while organic growth over the last 6 years was between 1-2 per cent per year. 
The recent decline in growth rate due to their large market cap. If they continue to use the same strategy of acquiring small companies (~$6M), growth will be slow moving forward. In order to sustain its growth, it must start looking into larger acquisitions, which carry more risk. 

Constellation is historically profitable (TTM: $4.8B revenue and $380M net profit), carries little debt, and generates solid free cash flows ($3.2B over the last 5 years). 

Constellation Software has six operating segments: Volaris Group: focuses on acquiring software businesses serving various areas, including agri-business, financial services, and education. It has approximately 45 constituent software businesses. Harris Computer Systems: primarily serves the public sector, including utilities, education, and healthcare. It has 31 constituent businesses. Jonas Software: operates 70 companies, primarily in the hospitality and construction sectors. Vela Software: operates 8 divisions, primarily focuses on the industrial sector, including oil and gas and manufacturing Perseus Operating Group: operates in a variety of industries, including home building, pulp and paper, and real estate Total Specific Solutions: focuses on software companies in the UK and Europe

PAST PICKS: January 21, 2021

Accenture PLC (ACN NYSE) 

• Then: $257.94
• Now: $355.31
• Return: 38%
• Total Return: 39%

Qualcomm (QCOM NASD) 

• Then: $164.75
• Now: $180.99
• Return: 10%
• Total Return: 11%

C3.ai (AI NYSE) 

• Then: $130.01
• Now: $26.27
• Return: -80%
• Total Return: -80%

Total Return Average: -10%