May 9, 2018

Mario Mainelli's Top Picks: May 9, 2018

BNN Bloomberg

Mario Mainelli , BNN Bloomberg

Mario Mainelli, portfolio manager at Caldwell Investment Management
Focus: North American equities

_______________________________________________________________

MARKET OUTLOOK

Markets continue to be quite volatile and in the U.S., many investors remain torn. On one hand, the U.S. economy is strong, there are record S&P 500 earnings and more attractive multiples than we’ve seen in a long time. On the other, interest rates are rising, inflation expectations are climbing due to higher wages and commodity prices, and we’re yet another year into an elongated bull market cycle.

Canadian investors also have much to think about. Rising commodity prices can be a boon to the economy and stocks, but NAFTA negotiations, heightened consumer debt and new restrictive mortgage rules provide considerable uncertainty.

We believe the reintroduction of volatility will be beneficial to stock pickers, particularly those with high conviction, concentrated portfolios. We continue to focus on quality companies that can deliver shareholder value regardless of the environment that they operate in.

TOP PICKS

DELPHI TECHNOLOGIES (DLPH.N)

ABOUT: Delphi provides products that optimize the powertrain of the vehicle (essentially what allows the vehicle to move), while meeting new emissions and fuel economy requirements. This includes fuel injection/handling, valvetrain, and other products.

THESIS:

Strong competitive positioning. The company 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 original equipment manufacturers (OEMs) and, given the high degree of technical expertise, the switching costs are high.
Secular growth drivers. We’re in the early innings of several long-term automotive trends of which Delphi is incredibly well-positioned for:
- More efficient vehicles. With a goal of reducing emissions, the majority of automotive markets will be enforcing higher efficiency requirements for vehicles with internal combustion engines (ICE). Delphi has a variety of powertrain technologies that OEMs will be utilizing to help meet these stringent requirements, such as advanced valvetrain and gas-direct injection.
- Electrification. Electrified vehicles (whether pure EV or hybrid) are expected to grow at 32 per cent compounded annual growth between 2017 and 2025. Delphi has significantly higher content per vehicle (CPV) on electrified vehicles versus traditional ICE vehicles. For example, Delphi’s CPV on an ICE vehicle is about $300, but this climbs to $1,000 -$1,500 for hybrid/full EVs, respectively. EV adoption is expected to be most pronounced in China (an area of strong exposure for Delphi), where EV incentives and quotas are being put in place for OEMs in an effort to fight the pollution problem.
Great risk/reward. Automotive suppliers in general currently trade at depressed multiples, which we suspect is due to several industry fears. Delphi is no exception, trading at just 11.5 times next year’s earnings, a near 30 per cent discount to the S&P 500, despite having good visibility to mid-single digit revenue/low double-digit cash from operations growth annually over the next five plus years. Below, we outline two of the main fears and why we believe they are overblown.
- “Peak auto” production in the U.S. Many investors may be hesitant to buy an auto supplier late in the U.S. auto production cycle. While it may or may not be true that U.S. auto production has peaked, most analysts and OEMs project U.S. auto production to remain at healthy levels and decline slowly over the next several years. This is vastly different from the way the last cycle ended (an abrupt drop off a cliff), which remain fresh in many investors’ minds. Auto suppliers have healthy profits at these levels of production. Furthermore, Delphi has significant exposure to Europe and Asia Pacific, limiting its exposure to declining U.S. production. Lastly, Delphi’s growth is driven by higher content per vehicle, which means Delphi could drive considerable growth even in an environment of production decline.
- Electrified vehicles jeopardizes auto suppliers. While it may be true that many auto suppliers will be hurt from the trend toward electrification, Delphi is actually a significant winner here, as described above. The long-term nature of auto platforms gives Delphi good visibility to the pace of adoption and it should be a significant catalyst when EV adoption picks up post 2020.

The solid growth expected from the company over the next five years combined with the strong probability of multiple expansion leaves us with confidence that the stock will be trading substantially higher in the years to come.

AMERISOURCEBERGEN (ABC.N)

ABOUT: AmerisourceBergen is one of the three major pharmaceutical distributors in the U.S. AmerisourceBergen is able to utilize their scale through a purchasing partnership with Walgreens to buy drugs from the manufactures in bulk and supply them to pharmacies, hospitals and physicians at lower prices than they could achieve on their own.

THESIS:

Distributors are an integral part of the healthcare supply chain and their scale/expertise provides a sizable moat.
Several headwinds, namely generic price deflation and fears of Amazon entering the market, have pressured the distributors over the past few years. As these headwinds subside (generic deflation is stabilizing and Amazon fears are subsiding), we believe the distributors will get a positive multiple rerate.
Of the three large distributors, we believe AmerisourceBergen is the best positioned for several reasons:
- Lowest net debt gives the most ability to add shareholder value through buybacks and acquisitions.
- Strongest specialty business of the three ( about 20 per cent of revenue), which has higher growth and better margin profile.
- Least contract repricing risk over the next few years, with the majority of revenue locked up through 2020.
- Walgreens is AmerisourceBergen’s largest customer ( about 30 per cent of revenue) and their acquisition of Rite Aid is a source of growth.

TRICON CAPITAL (TCN.TO)

ABOUT: Tricon Capital is an asset manager focused on real estate in the high-growth Sun Belt states. They operate mainly in three segments:

They buy, develop and resell land to home builders
They have a portfolio of single family houses that they rent, effectively institutionalizing the traditional ‘ma and pa’ rental market.
They’re developing and renting out luxury apartment buildings in major urban cities, namely Toronto.

THESIS:

Tricon is a diversified way to play the recovery in the U.S. housing market. We specifically like their exposure to the Sun Belt, which is experiencing growth above the national average. They invest in land and houses directly, receive consistent rental income and also get management fees for side cars that they manage.
Unlike a REIT, they’re very flexible and opportunistic in their investments, which allows for greater potential returns over time.
Their largest segment, single family housing rentals (SFR), is particularly attractive. They have a good formula in place in which they’re essentially institutionalizing the SFR market: they buy a single family house in a growing market, complete some minor renovations/upgrades, increase the rent accordingly, centralize the maintenance costs, and often get the added benefit of housing price appreciation.
Tricon recently made a large and accretive acquisition in the SFR segment (Silver Bay Realty), which significantly grows its earnings power.
They trade at an attractive multiple that likely doesn’t properly factor in their potential growth.

DISCLOSURE	PERSONAL	FAMILY	PORTFOLIO/FUND
DLPH	N	N	Y
ABC	N	N	Y
TCN	N	N	Y

PAST PICKS: FEB. 15, 2018

AG GROWTH (AFN.TO)

We still own Ag Growth. They’re down slightly (by 2 per cent) since Feb. 15, but the company had a good report today and the stock is reacting positively. There’s still a long runway of growth, driven by the fact that most countries are underinvested in farming storage.

Then: $56.18
Now: $57.16
Return: 1.74%
Total return: 2.88%

MITEL (MNW.TO)

We still own Mitel. They’ve had a fantastic run (23 per cent since Feb. 15 and 40 per cent year-to-date). This had been driven by the market gaining appreciation for their strengthened cloud position and potential multiple rerate upwards after its Shoretel acquisition. This eventually led to the company being acquired by private equity firm Searchlight Capital. We continue to hold, however, as there’s a 45-day go-shop period and a good probability for a higher offer from a different buyer.

Then: $11.07
Now: $14.33
Return: 29.44%
Total return: 29.44%

DELPHI TECHNOLOGIES (DLPH.N)

We still own Delphi. It’s been soft recently (down 6 per cent since Feb. 15) as have many stocks that are perceived to be cyclical. Delphi had a good earnings report today, which we hope will be a catalyst for the stock moving forward. They’re very well positioned for several secular growth drivers and we believe the market is underappreciating this.

Then: $51.96
Now: $49.48
Return: -4.77%
Total return: -4.42%

Total return average: 9.3%