January/February 2017 | Caldwell Balanced Fund Commentary

Caldwell Balanced Fund Update January/February 2017

Contents:

Portfolio Additions & Deletions: None

Company updates

– Tricon Capital Group – Cognizant – CCL Industries

Market Commentary

– How Long Will the Trump Trade Last?

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Company Updates

Tricon Capital Group

Unlike a typical REIT, which tends to own real estate properties indefinitely, Tricon actively re-allocates capital to where it sees the best investment opportunities, focusing on the residential market. Tricon recently made significant changes to its capital allocation plan, including more than doubling the size of its single family rental home portfolio through the acquisition of Silver Bay Realty Trust, and its planned exit of its manufactured land lease and US multi-family development businesses. The Silver Bay acquisition will make Tricon the 4th largest owner of single family rental homes in the U.S. Given Tricon’s recently in-sourced property management operations and the geographic overlap of the homes acquired, the acquisition should create considerable scale and operating synergies.

The deal is an attractive one as it is expected to be accretive to both earnings per share and net asset value per share in the near term, with further potential synergies realized over time. Additionally, by exiting the aforementioned businesses, Tricon’s capital (and management) will have greater focus on the business units where they see further scale and growth opportunities.

Since our initial purchase in June 2016, Tricon has gained 24% through the end of February versus the TSX at 7.6% and an unchanged REIT index. We see an attractive combination of a discounted valuation and sizable growth opportunity in Tricon and expect shares to continue to move higher.

Cognizant

Cognizant’s valuation multiple has contracted nearly 30% since the beginning of 2016 and has created a drag on the overall portfolio. Investor concerns around slowing growth and the potential for regulatory-driven cost increases have created a situation where shares, which historically commanded a premium, now trade at a discount to both its peer IT consulting group and the broader market (S&P 500).

This has attracted the attention of renowned activist investor Elliot Management, which acquired a 4% stake in the company and is now working with the Board on a comprehensive plan to increase shareholder value. The plan includes increased focus on the company’s higher growth digital segment, a commitment to increase operating margins through improved efficiencies and automation, and a $3.4 billion capital return plan over the next two years that includes the initiation of a dividend and accelerated share repurchases. 

While most investors would like to see the stocks they own move straight up after they buy them, experienced investors know that’s not the way the world works. Ultimately, we think Cognizant will turn out to be a great example of how the market can create attractive investment opportunities when great businesses face temporary headwinds, something we are constantly on the lookout for.

CCL Industries

A stock that has gone nearly straight up since we purchased it in August 2012 is CCL Industries (up from $37 to $282 at the end of February). We wrote about the company’s accretive and transformative acquisition of Innovia, a specialty security technology leader, in our last note. Since then, CCL announced strong Q4 earnings which saw a re-acceleration of their organic growth rate to 4% and a 5:1 stock split. We continue to own CCL as they execute well on their strategy of moving to higher margin, more specialized product offerings and build scale in a fragmented market.

Market Commentary

How Long Will the Trump Trade Last?

This is a frequent question we get from investors. The fear is that the U.S market (S&P 500) has risen by 10.5% since the November election, and that it will surely come crashing down as President Trump’s promises face the reality of the office. As we have previously written, the last 7 years (since the market bottomed in 2009) has shown investors how difficult it is to predict a market’s top: double dip recession fears, Greek bailouts, terrorism, Brexit, a commodity crash, massive currency fluctuations – none of these have derailed the market. We offer three additional things to consider to those worrying about a market top:

1. We continue to see reasonably priced stocks in the market, especially in the context of low interest rates. Our view is that it is more attractive to own companies that generate free cash flow yields above current bond yields and that also have the opportunity to grow. Unlike today, where the earnings yield on the S&P 500 is above the U.S. 10-year bond yield, we note that for large periods of history, the equity yield was below the bond yield as investors gave up yield for the prospects of growth.
2. When something does derail the market, it is not likely to be a daily news item. Rather, it is typically something unexpected.
3. It seems that people are still more worried about a market crash than about ‘missing out’, which implies that we are still not seeing the exuberance typical of market tops.

We appreciate your continued support.

Best Regards,
Portfolio Management Team