Portfolio Additions
AmerisourceBergen (ABC-us)
About the Company: ABC is the leading pharmaceutical distributor in the U.S. and competes directly with Cardinal Health (CAH).
Investment Thesis: We purchased ABC as a replacement for CAH. In addition to getting a slightly better cash flow yield with ABC, we also get a better balance sheet, better positioning in the higher growth specialty segment, less contractual risk, better management and also remove headwinds form CAH's medical supplies business. The industry continues to trade at a sizable discount to the market but we believe this gap will close as deflationary trends are improving and the group benefits from the recently-enacted U.S. tax plan.
Mitel Networks (MNW-us)
About the Company: Mitel is a leading provider of communication tools to businesses and other organizations (hotels, hospitals, schools, etc). Its focus is on unified communications and collaborations (UCC) which serve to integrate different types of communication tools across different end users, geographies and devices.
Investment Thesis: Mitel trades at a significant discount to the market and peers and we believe the shares can move meaningfully higher as focus shifts from their legacy on-premise to their growing cloud platforms. The 2017 acquisition of Shoretel increased Mitel's recurring revenue to 40% of total revenue and increased recurring cloud revenue, which is growing at a double-digit pace, from 12% to 20%. Mitel has a large installed base of 60 million on premise users of which only 1.5 million have converted to the cloud model, providing a long runway of cloud growth. We also expect margins and cash flow to significantly improve on the combination of cloud growth, cost initiatives, Shoretel synergies and interest savings.
Berry Global (BERY-us)
About the Company: Berry is a leading specialty plastics producer whose products are used in a diverse set of end markets, including the health & personal care, household, food & beverage, food service, industrial and transportation markets.
Investment Thesis: BERY is a leader in the fragmented specialty plastics industry where its scale allows it to be the low cost producer. With $7 billion in revenue within a $200+ billion packaging industry, the company has continued growth runway through a successful acquisition strategy that has resulted in meaningful earnings per share growth. With approximately 2/3 of revenue tied to stable end markets, we expect BERY to provide stability to the portfolio. From a valuation standpoint, we view BERY's 5% free cash flow yield, which ranks in the top 15% of our screening universe, as attractive.
TE Connectivity (TEL-us)
About the Company: TE is the largest global manufacturer of connectors, which protect the flow of power and data inside of millions of products used daily by consumers and industries. It has leadership positions in each major end market -transportation, industrial equipment, energy and consumer - and generates $13 billion in revenue within a $70 billion addressable market. TE does particularly well in 'harsh environments' which are characterized by extremes in temperature, pressure and vibration with exposure to fluids. TE also supplies sensors that measure and respond to pressure, temperature, humidity, position, force, vibration and other readings.
Investment Thesis: We expect TE's growth to accelerate on the back of several secular trends. These include the advancement of safety, efficiency/electrification and connectivity of the auto and other vehicles (TE's content per vehicle is expected to grow from the low $60s today to over $100 over the next 8 years), continued factory automation and demographic-driven growth in medical devices where TE specializes in minimally invasive procedures. We also expect further margin growth driven by TE's lean operations model. Despite these strong tailwinds and a high teens return on equity that ranks TE in the top 30% of our screening universe, the stock trades at a slight discount to the S&P500 and generates twice the free cash flow yield of our screening universe.
Stantec (STN-t)
About the Company: Stantec is the 3rd largest design firm in North America and provides engineering, architecture, and project management services to Infrastructure (28% of revenue), Buildings (22%), Water (22%), Environmental Services (17%) and Energy & Resources (11%) projects. STN has 22,000 employees and operates in 400+ locations globally.
Investment Thesis: STN is a high quality business that has under-performed peers on the back of oil & gas/resource exposure and several self-inflicted, but temporary (in our view) missteps. We believe these issues are behind the company and several catalysts suggest a higher share price going forward, including: 1) Analyst estimates have been reset lower, thereby reducing the likelihood of additional disappointments; 2) Infrastructure spending is picking up and STN should benefit given its leadership positions in key verticals; 3) Commodity prices have moved higher suggesting STN’s commodity-related verticals have likely seen a bottom; 4) A new CEO helps put recent missteps in the rearview mirror; 5) Renewed acquisition after an extended integration period. At the time of purchase, STN traded at a 5.2% free cash flow yield versus 4.6% and 3.0%, respectively for peers TTEK and WSP despite significantly higher return on equity. Versus our broader screening universe, STN has a higher return on equity, better balance sheet, lower capex requirements, greater profitability, equal to or greater growth opportunity and yet trades at over two times the universe's free cash flow yield at 5.2%.
Delphi Technologies (DLPH-us)
About the Company: Delphi Technologies, a recent spin-out from Delphi Automotive, is a leader in products that optimize a vehicle’s powertrain.
Investment Thesis: DLPH 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 its high degree of technical expertise, benefits from high switching costs. The company is well-positioned to benefit from: 1) Regulatory-driven reductions in vehicle emissions; 2) The shift from combustion to hybrid/electric-vehicle (EV) systems (where Delphi carries five times the normal engine content); and 3) A cyclical recovery in commercial truck/aftermarket volumes. We believe these growth opportunities, coupled with margin expansion and a multiple re-rate to reflect its status as a beneficiary of EV systems, will drive the stock price meaningfully higher.
Portfolio Deletions
Cardinal Health (CAH-us)
Reason We Sold: See ABC thesis, above.
Robert Half (RHI-us)
Reason We Sold: RHI is up ~50% since the late 2016 lows on speculated (and now confirmed) benefits from U.S. tax reform and a strengthening U.S. economy. Our concerns stem from RHI's commentary surrounding lengthening conversion cycles and this leads us to wonder if something has structurally changed for the recruiters, particularly as companies like Google and LinkedIn (Microsoft) look to leverage their vast databases. As such, we see better risk/reward in the opportunities added to the portfolio.
Apogee (APOG-us)
Reason We Sold: We sold APOG following another weak quarter as our investment thesis is not playing out as expected. Despite favorable end market dynamics and a leadership position in the industry, the pricing environment has become more competitive as its peers look to stem market share losses. While management continues to be positive on the future, they have lost credibility in our minds as previous positive commentary failed to materialize.
Kohl's (KSS-us)
Reason We Sold: We sold KSS into share price strength driven by better traffic results, expected benefit from U.S. tax reform and optimism on its new relationship with Amazon. KSS has struggled with traffic for years, despite management's sole focus on traffic-driving initiatives, and ultimately, we haven't seen any evidence that secular headwinds from online shopping will reverse. While the relationship with Amazon may prove to be the initiative that finally gets traffic going, no economics have been provided on the arrangement. We continue to view consumer trends as hard to predict and quick to change and as such, prefer exposure to the companies noted above.
Accenture (ACN-us)
Reason We Sold: ACN was a strong performer, +64% since our initial purchase in September 2015 versus +42% and +21% for the S&P 500 and S&P/TSX Composite, respectively. We continue to view ACN's business favorably and maintain exposure through its peers, Cognizant (CTSH) and CGI Group (GIB.A), both of which are trading lower valuations. We simply needed a source of cash for the opportunities outlined above.
Commentary: 2017 Performance Review & 2018 Outlook
- The portfolio being over-weight the Technology sector, which out-performed the broader markets in both the U.S. and Canada;
- Security selection in Materials stocks, driven by CCL Industries;
- Security selection in Financials stocks, driven by KKR, Citigroup and Onex.
Top detractors included:
- Security selection in Technology stocks, driven by Celestica and Amdocs and the lack of exposure to Apple and Facebook;
- Security selection in Consumer Discretionary stocks, driven by Omnicom and Whirlpool and the lack of exposure to Amazon;
- Security selection in Industrials stocks, drive by Apogee.
Table 1 - Top and bottom contributors to performance in 2017
One of the more interesting things about 2017 was the apparent shift in investor psychology. Up until the latter part of the year, fear (is this the top? are we headed for another crash?) and disbelief/skepticism (how can markets make new highs with Brexit and Trump), seemed to dominate investor thinking. As markets continued to reach new highs, however, ‘fear of loss’ seemed to shift to ‘fear of missing out.’ It has once again become exciting for people to talk about the markets and the amount of questions and money being thrown at unproven business models in digital currencies and marijuana is telling. While these are signs that the market is closer to a top than a bottom – we buy into the ‘cycle of emotion’ where market bottoms coincide with extreme fear while tops come with extreme exuberance – predicting the timing of when the top will occur is anyone’s guess. This creates difficulty given we live in a world where performance returns are published on a daily basis. Most pundits expected higher volatility in 2017 (an erroneous forecast). That forecast has now shifted into 2018.
Our recommendation to investors is to have a conversation with their investment advisors on cash needs. If money is required in the next year or two, it may be wise to lock in some gains.
While not evident by performance last year, we continue to believe that a focused portfolio of ~25 stocks targeted at select company-specific opportunities will serve investors well going forward. As outlined above, we have made meaningful changes to the portfolio in the last several months. Studying where we have recently under-performed, while we owned high quality companies trading at attractive valuations, these companies lacked catalysts or growth opportunities to move the share prices higher. This is something we have targeted in the purchases made since this past summer; results on these investments have been encouraging thus far and we look forward to tracking the portfolio’s progress as we move forward.
We appreciate your continued support.
Best Regards,
Portfolio Management Team
The information contained in this document is designed to provide general information related to investment alternatives and strategies and is not intended to be investment or any other advice applicable to the circumstances of individual investors. We strongly recommend you to consult with a financial advisor prior to making any investment decisions. Unless otherwise specified, information in this document is provided as of the date of first publication and will not be updated. All information herein is qualified in its entirety by the disclosure found in the Caldwell Balanced Fund’s most recently filed simplified prospectus. Information contained in this document has been obtained from sources we believe to be reliable, but we do not guarantee its accuracy. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing in this product. Unless otherwise indicated, rates of return are the historical annual compounded total returns including changes in unit value and reinvestment of all distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. The Caldwell Balanced Fund is a publicly offered mutual fund that offers its securities pursuant to a simplified prospectus dated July 20, 2017. Inception Date: Series A - March 1, 1990, Series F – July 4, 2014, Series M – July 15, 2016. Principal distributor: Caldwell Securities Ltd.
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