October 2017 | Caldwell Balanced Fund Commentary

Portfolio Additions

LCI Industries (LCII-us)

About the Company: LCI Industries is a leading supplier to RV OEMs where it holds #1 or #2 market share positions in its product lines. It is also a supplier to the manufactured housing and marine industries (18% of sales) and has an aftermarket business (8% of sales). LCI generates 98% of revenue in the U.S.

Investment Thesis:

  1. Strong RV Demand: RV units are on track to grow 11.5% over 2016. Strong demand is being driven by several factors, including demographic tailwinds from aging baby boomers and stronger interest from millennials.

  2. Incremental Growth Opportunity: LCI has identified $4 billion in revenue opportunity, which provides a long growth runway given the company currently generates $1.8 billion in revenue. The company sees revenue growth of $200-$400 million per year over the next 3-5 years as it increases its content/RV, expands into adjacent industries, expands internationally, grows its aftermarket business and targets appliances and electronics. LCI has shown strong execution in these areas already – for example, content per vehicle has doubled in the last 10 years and aftermarket and International revenues have doubled in the last few years.

  3. Strong Barriers to Entry: LCI has very strong relationships with its key customers given its strong innovation focus. The company outspends its competitors on innovation and has unmatched product breadth. This has translated into double digit Return On Equity (ROE) over the cycle.

  4. Valuation Appears Attractive on Peak Cycle Fears: Investors seem very much fixated on the U.S. RV market and when the cycle will top. However, management noted that $2.2B of the $4B identified opportunity is outside of the U.S. RV market. Additionally, investors seem to be anchoring to the 08/09 downturn, which was rather harsh. Looking at prior cycles, declines are more reasonable and management expects to be able to offset industry-driven declines with these other opportunities.  With an excellent balance sheet (only $12M in net debt) and cash flow that should inflect positively going forward, we believe LCI is an attractive opportunity for investors.

Tyson Foods (TSN-us)

About the Company: TSN is the largest diversified protein company, fully integrated chicken producer and beef processor, and third-largest pork processor in the U.S. It is also now one of the largest prepared meats producers following its acquisition of Hillshire Brands in 2014. TSN generates 98% of revenue in the U.S.

Investment Thesis:
  1. Moving Up the Value Spectrum: TSN has done a very good job of transitioning its business away from commoditized products, which generate lower margins and higher earnings volatility, and into higher value add product. Today, an estimated 65% of their operating profit comes from value-add products; as margins increase and earnings become smoother and more predictable, the stock's valuation multiple should continue to expand.

  2. Playing Into Consumer Trends: Protein fundamentals remain strong and consumers are increasingly demanding high-quality food in convenient “on-the-go” packaging. This plays into TSN's move into higher value products.

  3. Synergies from the APFH Acquisition: TSN acquired AdvancePierre Foods in early 2017. The company is a leading national producer and distributor of ready-to-eat sandwiches and other snacks to foodservice, retail and convenience stores. The acquisition provides significant cost and cross-sell opportunities.

  4. Strong Competitve Position: With leading or very strong market share in every segment in which they operate, Tyson's extensive expertise and considerable scale advantage act as large barriers to entry.

Portfolio Deletions

Chevron (CVX-us)

Reason We Sold: After years of high capital spending on massive projects, Chevron’s cash flow is beginning to inflect higher. These projects are ramping up production, capital spending is moving dramatically lower, and the company has secured an enviable position in the Permian basin, the hottest play in energy this past year. We originally bought Chevron into concerns around its heavy capital investment; now that that period is over, our investment thesis has played out. While energy has been a bad place to be since our initial purchase of Chevron in April 2012, the stock has significantly outperformed the TSX Energy sector (+15.5% versus -8.8% for the sector). The stock has held up remarkably well through the energy downturn….at the current price of $118/share, Chevron is trading at the same level as it did in April 2014, when crude was over $100/barrel (versus ~$52 today).

Omnicom (OMC-us)

Reason We Sold: While Omnicom is a very profitable business that generates consistent earnings results, growth opportunities are becoming more elusive as consumer product companies, who are large Omnicom clients, face their own growth challenges amidst intensifying competitive pressures. Competitive threats are also growing for Omnicom, particularly from technology consultants who are broadening their offerings into the marketing sphere (this fund has good exposure to technology consultants through Cognizant, Accenture and CGI Group). We believe these headwinds can persist for some time and will keep a lid on Omnicom's share price; as such, we believe TSN and LCII are better opportunities.

Commentary: Reviewing Performance Year-to-Date (to September 30, 2017)

Performance this year has been frustrating. In some cases, its been justified while in many others, recent headwinds seem to be setting the portfolio up for stronger performance going forward. We discuss these below.

Unexpected Rate Rises Create Currency Headaches:

Through September, the U.S. market (S&P 500) was +12.5% year-to-date versus +2.3% for the Canadian market (TSX Index). This should have been a positive for the portfolio given its greater exposure to the U.S. market (~65% versus 35% for Canada), but strength in the Canadian Dollar "CAD" (or, relative weakness in the U.S. Dollar "USD") after two unexpected rate hikes by the Bank of Canada masked these results. At its recent peak (82.18 cents/USD on September 8th), the CAD was 10.4% higher than its 74.46 cent/USD level at the start of the year. That translates into an ~9% headwind on individual U.S. holdings and a 6%+ headwind on a portfolio with 65% U.S. exposure. Given that Canada's growth has been largely driven by consumer and government spending, which are debt-fuelled given underwhelming growth in business investment and exports, we were (and remain) comfortable with our USD exposure. The rate hikes were based on data that had very easy prior-year comparisons, making growth in Canada look un-sustainably high. As year-over-year compares get more difficult, we have seen more tepid economic results and are now seeing the Bank of Canada back-peddle on their decision in an effort to talk the CAD back down (a stronger CAD is not helpful to the Bank of Canada, whose plan entails stronger business investment on the back of higher exports - a stronger CAD makes exports less competitive, which creates a headwind to export growth).

Currency has Masked the Winners:

The portfolio's strongest performers have all been U.S. names (as expected, given the relative out-performance of the U.S. market). KKR, Steris and Cognizant are all up ~30% this year while Amdocs, Broadridge and Accenture have also made new highs recently. We continue to see attractive growth opportunities at these companies, all of which are industry leaders and/or are benefiting from strong end market demand.

Some Deserved Underperformers:

Energy: The portfolio has particularly struggled with its energy servicers positions, with Trinidad Drilling and ShawCor down 43% and 23%, respectively, this year. Our performance in the Energy sector has been both very good and very bad. On the integrated side, Suncor and Chevron have performed very, very well. As mentioned, Chevron is trading at the same level as when crude was over $100 while Suncor is actually out-performing the broader TSX since we initiated a position in early 2014. The servicers, however, have been significant drags on the portfolio. Trinidad has been particularly frustrating as its been a cheap stock that has only become cheaper. The cyclical recovery seems to be continually being pushed into the future and it hasn't helped that management has been making questionable investments. As one analyst put it to us: "...there is lots of asset value here but its not getting any respect/love from the [market]."  While the extended industry downturn has been frustrating, we have been seeing better tone from management and we think the shares can move meaningfully higher from here. Shawcor is a very high quality company and industry leader. The stock could see continued volatility in the short-term as 2018 is an 'air pocket' of project work, but 2019 and beyond look very promising on high levels of budgetary and bid work.

Amazon: An analyst we recently spoke to stated that "the laws of valuation don't apply to Amazon." While the stock prices of most companies are anchored to earnings or cash flow generation, this does not seem to be the current case with Amazon. We under-estimated the impact of changing consumer preferences on Kohl's, which has struggled with declining customer traffic despite numerous initiatives to reverse the trend. Interestingly, Kohls recently signed a partnership with Amazon that will carve out a section of its stores to offer Amazon's home devices like Echo, and allow returns of products purchased on Amazon's website. Given the valuation discount to the market, and that Kohls has a unique position versus other department stores with its off-mall store footprint, we think shares ultimately move higher. Due to how quickly consumers can change their minds, and how difficult that makes it on companies that sell to consumers, we have largely shied away from the consumer space, preferring to invest in companies whose customers are other businesses. The Amazon effect is another reason to continue doing so.

Looking Forward

We have added 5 new stocks to the portfolio over the last several months (TFII, SOY, KEYS, LCII and TSN) that have strong catalysts that we believe will propel shares higher for investors. These join the group of strong performers that have been making recent highs and have additional runway of opportunity. The FX headaches have begun to reverse and we expect stocks that have been overly-penalized by the market to recover.  We continue to use a 2-3 year time frame when selecting investments as this allows us to look beyond the 1-year outlook that analysts work off of.

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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