Stephen Takacsy, president, CEO and chief investment officer at Lester Asset Management
Focus: Canadian equities

MARKET OUTLOOK

After rebounding strongly in 2019 as fears of an impending recession faded and central banks cut interest rates, equity markets are now choppier as the U.S.-China trade war drags out and corporations start feeling the impact. Large-caps have become extremely expensive as a result of passive ETF investing to the detriment of small- and mid-cap stocks, which have gotten even cheaper. Michael Burry of The Big Short fame recently called this phenomenon the index bubble or ETF vortex and he is investing heavily in small-cap value stocks worldwide. We also see many good long-term opportunities in the neglected and mispriced Canadian small- and mid-cap sector, at valuations well below private market values. IPOs such as Uber priced at ridiculously high valuations signaled a market top for money-losing tech stocks, which are now starting to deflate with WeWork’s failed IPO and its valuation now a fraction of the last private equity round.

TOP PICKS

DIAMOND ESTATES WINES (DWS:CV)

Diamond is the only publicly traded wine company in Canada besides Andrew Peller and the third-largest producer in Ontario. The stock is down this year because of lower export sales to China and loss of two customers at their agency business a year ago, but this is old news. The company is now growing again in all three segments: exports, agency and Ontario retail sales, where Diamond has the largest market share of Vintners Quality Alliance (VQA) wines. The company is benefitting from deregulation in Ontario, where hundreds of grocery stores have started selling wine.

The big news is that Diamond recently announced in July that Lassonde Industries (one of North America’s largest juice companies) has acquired a 20-per-cent stake in the company. This is a game changer. Lassonde has a huge national salesforce which should increase Diamond’s sales to grocery stores across Canada and as well as its agency sales in Quebec. Lassonde also has strong manufacturing and packaging expertise. In addition to improving results over the next few quarters, we also expect Lassonde to acquire the entire company at a large premium to the current share price within the next few years. We recently bought another 4 million shares at $0.19 and increased our ownership to 9.4 per cent of the company.

TECSYS (TCS:CT)

Tecsys is a Montreal-based supply chain management software solutions provider specializing in complex distribution to hospitals, mainly in the U.S., and other high-volume businesses (procurement, warehousing, transportation, sales and distribution and accounting). Tecsys also made two recent acquisitions to expand their reach into Europe (Denmark’s PCSYS) and e-commerce (Toronto’s OrderDynamics).The company is in the process of transitioning from a perpetual license to a software-as-service model, which temporarily depresses reported revenue. We bought the stock recently at an attractive valuation as it pulled back on this perceived slowdown in growth. Meanwhile, the company recently reported a record backlog and rising high-margin recurring revenue which the market will reward with a higher multiple in the future. 2020 should see strong growth in revenue to over $100 million and EBITDA. Tecsys only trades at two-times revenue versus the peer average at four times. 

BAYLIN ( BYL:CT)

Baylin is a leader in wireless antenna design for mobile, network and infrastructure applications (wi-fi coverage, wireless network densification using small cell systems, and antennas needed for 5G networks). The stock has been demolished since it issued an earnings warning a few weeks ago due to lower capex by U.S. carriers, but it also announced the largest contract in its history with one of the world-leading telecom equipment suppliers for 5G antennas (likely Samsung, Nokia or Erickson). The overreaction is an example of the market’s “shortermism” with stocks these days. Baylin will benefit from huge infrastructure spending over the next 25 years. It’s expected to see a significant increase in sales in 2020 revenues expected to reach $170 million and EBITDA of $20 million. At $2 per share, Baylin is only trading at an enterprise value of six times 2020 EBITDA. Our target price is $4 to $5 within 12 to 24 months based on nine to 10 times 2021 EBITDA similar to peer group.

PAST PICKS: DEC. 3, 2018

CENTRIC HEALTH (CHH:CT)

• Then: $0.295
• Now: $0.13
• Return: -56%
• Total return: -56%

VELAN (VLN:CT)

• Then: $8.87
• Now: $6.86
• Return: -23%
• Total return: -21%

NFI GROUP (NFI:CT)

• Then: $37.36
• Now: $28.67
• Return: -23%
• Total return: -19%

Total return average: -32%

WEBSITE: www.lesterasset.com