Full episode: Market Call Tonight for Friday, October 20, 2017
William Chin, portfolio manager at Caldwell Investment Management
FOCUS: Technical analysis and macro portfolio strategy
The two interest rate increases by the Bank of Canada would arguably be the most important development in the past few months, as we are now seeing the consequences. On Friday we had the August retail sales report, which shed light on consumer spending. Overall sales fell 0.3 per cent, excluding autos sales falling 0.7 per cent. These are sharp reversals from July’s moderate gains.
The first rate hike was on July 12, so August would have felt the impact. The second hike was on September 6, so wait for September and October numbers to tell us the impact of the second hike. In the three months ending August, Canada has lost 10 per cent of our exports, because the Canadian dollar was too strong. July GDP was flat. The element of surprise is arguably the most potent tool in a central bank’s tool box, and those two hikes did exactly that. Also, the elevated levels of household debt will amplify the impact of the rate hikes. So the Canadian economy has a lot to deal with, apart from NAFTA and new regulations on housing.
South of the border, things are volatile to say the least. Tax cuts are more difficult than health care reform. Passing the budget is a good start but there are lots of hurdles ahead. Look no farther than Canada and our struggles with our attempt to introduce tax changes. There are lots of uncertainties.
This is a challenging environment for investors. Active management is Caldwell’s philosophy and that is more important now than ever. When you use a robot advisor to buy ETFs, you are buying the whole market - that is, you are buying the good with the bad. Inside our Funds, our focus is selective U.S. stocks (as the Canadian dollar should go lower from here) and Canadian stocks that satisfy our requirements of possessing "value" and "momentum." They are often under the radar of most large mutual funds (they all hold the same stocks).
SLEEP COUNTRY CANADA (ZZZ.TO)
Sleep Country is a leading mattress retailer in Canada and the only specialty mattress retailer with a national footprint. Mattresses account for approximately 80 per cent of sales, with the remainder coming from mattress/bed accessories. We like Sleep Country for the following reasons:
- Competitive landscape. Sleep Country is a very strong operator that places a great deal of importance on having a well-trained sales staff. As such, they continue to take share from competitors through strong execution and we expect this trend to continue. They have been able to take shares from several key competitors such as Sears Canada (recently filed for bankruptcy protection) and Hudson's Bay (they have done well on their turnaround effort but mattresses are not an areas of focus for them), as well as smaller regional players.
- Increasing penetration of accessory sales. Sleep Country is in the early innings of rolling out higher-margin accessory products (sheets duvets, headboards, etc.). The traction here has been impressive and they continue to increase the focus on growing accessory sales.
- Store redesigns. The goal is to refresh 15-20 stores a year with more modern layouts that better highlight key products. The results have been very positive and are expected to continue to be a positive catalyst to sales.
Transcontinental is Canada’s largest printer with operations in print, flexible packaging, publishing and digital media. The bulk of their operations is associated with the printing/distribution of retail flyers and newspapers. They have also been expanding their footprint in the flexible packaging industry, which is their higher growth segment.
Their clients include retail flyers from Sobeys, Metro, Shoppers; newspapers (just print) like San Francisco Chronicle, Globe and Mail, Toronto Star; and publications/media (the content) like Investment Executive, Benefits Canada, educational/trade books.
We like Transcontinental for the compelling valuation. Transcontinental trades at a significant discount to the market driven by their exposure to print, which is in secular decline. We believe the stock warrants a higher multiple for several reasons:
- Misunderstanding of print segment. Some, if not most, investors do not properly understand their print segment and it is possible they assume much of it is in secular decline. However, much of the business, particularly that which is linked to retailers (per management, it is 65 per cent of print), is generally performing well and backed by long-term contracts. Furthermore, they are also relatively well-positioned in the parts that are in secular decline. For example, past investments combined with Transcontinental’s ability to remove cost through print platform optimization, have left them with a strong, low cost manufacturing footprint that enables them to take share of a declining newspaper industry as publishers continue to outsource ("last man standing"). Management has placed some focus on better explaining this to investors, which we believe will be well received.
- Exposure to flexible packaging. Packaging companies trade at a much higher multiple than print due to the growth characteristics of the industry. Transcontinental continues to leverage their strong manufacturing expertise to grow their packaging business both organically and through acquisition. This segment should continue to grow and account for a higher percentage of revenue.
- Strong free cash flow. We like Transcontinental's strong free cash flow generation as it highlights the efficiency of their operations. It also provides financial flexibility, which will be important as they grow their packaging business.
CGI GROUP (GIBa.TO)
CGI Group manages IT and business process services for clients, including outsourcing and system integration/consulting. We like CGI Group for the following reasons:
- Strong secular trend for consulting. As the global environment becomes increasingly competitive and as the technological landscape becomes increasingly complex, companies are increasingly relying on IT consulting firms like CGI to stay competitive. We see this as a trend that will continue for the foreseeable future.
- Improving growth profile. Organic growth and future bookings have improved in recent quarters. We believe growth will continue to improve on better spending in several markets, with particularly strong demand in digitalization. Furthermore, CGI has winded down much of their lower margin contracts and are replacing these with higher margin contracts.
- Potential M&A. CGI has a strong track record of acquisitions. The pipeline remains strong with several large potential deals available and CGI has the means to pursue such acquisitions if they are a good fit.
PAST PICKS: SEPTEMBER 16, 2016
IMVESCOR RESTAURANT GROUP (IRG.TO)
- Then: $3.11
- Now: $3.60
- Return: 15.75%
- Total return: 19.61%
SLEEP COUNTRY CANADA (ZZZ.TO)
- Then: $30.99
- Now: $38.74
- Return: 25.00%
- Total return: 27.48%
AGT FOOD AND INGREDIENTS (AGT.TO)
- Then: $36.23
- Now: $20.72
- Return: -42.80%
- Total return: -41.31%
TOTAL RETURN AVERAGE: 1.92%
Caldwell Canadian Value Momentum Fund
Performance as of: September 30, 2017
1 Month: 9.5% fund, 9.2% index
3 Year: 10.1% fund, 4.5% index
5 Year: 12.7% fund, 8.1% index
*Index: S&P/TSX Total Return Index
TOP HOLDINGS AND WEIGHTINGS
- WSP Global: 6.5%
- IBI Group: 6.0%
- CGI Group: 5.9%
- Cargojet: 5.6%
- Transcontinental: 5.4%