Teal Linde, manager at the Linde Equity Fund
Focus: North American mid and large caps

MARKET OUTLOOK

About 40 per cent of market gains during the last bull market came from multiple expansion. But given price-earnings multiples are already near all-time highs, can continued multiple expansion be counted on to meaningfully contribute to even higher stock prices? Can higher corporate profits save the day? About 25 per cent of share price gains in the last bull market resulted from profit margin expansion (excluding tax cuts) due primarily to declining interest rates and wages as a percentage of sales. Can interest rates fall much lower and will labour accept an even smaller share of the profit pie to further boost profit margins?

Sales growth contributed about 20 per cent to share price gains. Sales will likely continue to grow, but with slowing population growth, this will likely slow too thereby contributing less to further share price gains. Lower corporate taxes were responsible for about 10 per cent of share price improvement during the last bull market, but at the expense of extraordinarily large budget deficits. With a growing likelihood the Democrats win the White House and both houses of Congress, a Biden administration is expected to reverse part of the Trump tax cuts to fill some of the massive budgetary hole, reducing corporate profits.

It is difficult to see stocks achieving over the next decade the returns over the last bull market. Over the next several years, stock selection will prove the key determinant of investor returns. Owning disruptors, consolidators and high dividend yielders should be prioritized.

TOP PICKS

TIDEWATER MIDSTREAM AND INFRASTRUCTURE (TWM TSX)
Last purchased on April 20 at $0.46.

Tidewater’s priority is on deleveraging, with management continuing to guide to ending the year with net debt/EBITDA of 3 to 3.5 times, assuming the closing of the Pioneer Pipeline sale. The Prince George Refinery could ultimately provide significant upside if management uses free cash flow to reduce leverage.  Tidewater’s approximate $250 million market cap is not expected to remain low as either debt is paid down and/or shares are bought back. Birch Hill Equity Partner’s increased ownership to 24% also offers bullish indications.

WESTERN FOREST PRODUCTS (WEF TSX)
Last purchased on April 29 at $0.73.

Last year, Western Forest Products was engaged in a collective bargaining dispute that would result in the longest strike in B.C. coastal forest history. We sensed an opportunity to buy a well-managed and profitable company. Insider buying by senior management further strengthened our belief, but we never did act.

The strike eventually came to an end in February 2020, but  just as the company was getting operations back up and running, the coronavirus struck B.C. Western Forest Products’ share price took another dive as COVID-19 hammered the markets, this time to a nine-year low of 58 cents in March. Insiders, including the CEO and CFO, bought more shares in late March. The stock trades just above this price range today and appears attractive on a price/book and price/sales basis.

CIT GROUP (CIT NYSE)
Last purchased on June 11 at $21.76.

After undergoing a restructuring in 2008, CIT Group has transformed from a sub-scale global finance company with $90 billion in assets to a domestically focused mid-sized commercial bank with over $50 billion in assets. With commercial banks more sensitive and vulnerable to recession risks, CIT Group’s share price is down 50 per cent year-to-date. It also trades at 45 per cent of its tangible book value of $51. Yet, as a result of many divestures, the bank operates a much more focused and profitable business than in years past and is expected to maintain adequate capital strength throughout pandemic without tapping the equity markets. As a result, CIT offers significant torque to an improving outlook for corporate credit quality. CIT has bought back half of its outstanding shares in the last four years, assisted by proceeds from divestures. Its stock trades near 5.5 time normalized EPS and 4. times 2019 EPS of $5.27. Insider buying in March by the CEO and others also underscores management’s conviction.

PAST PICKS: JUNE 24, 2019

AIR LEASE (AL NYSE)

• Then: $39.70
• Now: $30.20
• Return: -24%
• Total return: -22%

SQUARE (SQ NYSE)

• Then: $72.71
• Now: $103.26
• Return: 42%
• Total return: 42%

TIDEWATER MIDSTREAM & INFRASTRUCTURE (TWM TSX)

• Then: $1.43
• Now: $0.70
• Return: -51%
• Total return: -49%

Total return average: -10%

WEBSITE: www.lindeequity.com