September 2018 | Caldwell Balanced Fund Commentary

Portfolio Additions

S&P Global (SPGI-us)

About the Company: S&P Global provides ratings, benchmarks, analytics and data to the capital and commodity markets worldwide. It has 20,000 employees in 31 countries, over 200 billion data points and serves 97 of the Fortune Global 100 companies. The company generates over $6 Billion in annual revenue and operates across four business segments: Ratings, Market Intelligence, Indices and Platts. Demand for SPGI's services is driven by growing debt levels, data-driven investment and corporate strategies, the growth of passive/index investing and derivatives & commodity trading. SPGI's geographic split: 60% U.S., 25% Europe, 10% Asia, 5% Rest of World.

Investment Thesis:
  1. A Great Business Model: Over 70% of revenue is subscription based with high renewals. SPGI's products are highly ingrained into customers' processes, creating stickiness in revenue and strong pricing power (annual price increases of 3-4% annually across most business lines). This translates into strong margins (70% gross and 48% ebitda).

  2. Favourable Demand Drivers: SPGI has multiple growth drivers in each business line and targets a mid-to-high single digit revenue growth rate. In Ratings, over $100 trillion in debt is set to mature over the next 5 years, all of which will require an updated rating. In Market Intelligence, SPGI is increasing user adoption by recently moving from a single-user to a corporate license model, which should translate into higher revenue over time. In Indices, the number of index/passive products continues to grow, with penetration outside of the U.S. still very low. Lastly, in Platts, growth will come from new commodities like LNG, where Platts expects to soon be named the benchmark for pricing.

  3. Technology Increasing Barriers: SPGI is increasingly using technology (AI) to increase efficiency in its Ratings business and improve insights from its 200 billion data points in the Market Intelligence business. Given the company's scale, this makes it increasingly hard for smaller companies to compete.

  4. Attractive Free Cash Flow Generation and Capital Allocation Policy: SPGI is a capital light business which means it does not need to invest a lot of cash in order to generate incremental revenue. This creates a strong cash flow stream, 75% of which gets returned to shareholders in the form of dividends and buybacks.


Ansys (ANSS-us)

About the Company:  Ansys is a global leader in engineering simulation software that is widely used by designers, engineers and researchers across a broad spectrum of industries. Simulation allows for the virtual testing of products using the fundamental principles of modeling, physics, mathematics and computer science. With simulation, customers are able to get instant feedback on new product design and functionality without having to build a physical prototype, which allows products to come to market faster and cheaper. Ansys’ geographic split: 40% North America, 30% Asia Pacific, 30% Europe.

Investment Thesis:
  1. Strong Competitive Position: ANSS holds the #1 market share (~25%) and is considered the gold standard of simulation. The software platform has high barriers given its complexity and unparalleled physics capabilities, which should become increasingly valuable as product complexity increases.

  2. A Great Business Model: 75% of revenue is recurring with 98% renewal rates. This translates into strong margins (90% gross and 40% ebitda).

  3. Favourable Demand Drivers: The market is growing 8-10% annually with 70% of R&D budgets still being spent on physical testing. Adoption should become widespread as technology is a race-to-the bottom tool: if your competitor starts coming to market faster and with better product, you don’t have much choice than to follow their lead.

  4. New Management with a Growth Focus: A new CEO has injected a growth focus and the runway appears long with additional applications for simulation software beyond a product's design and testing phase.


IPG Photonics (IPGP-us)

About the Company:  IPGP is the global leader in fiber laser technology. Lasers, alongside vision and robotics, are experiencing strong secular growth driven by the trend toward factory automation. Manufacturers have been replacing conventional technologies in cutting, welding and other material processing applications with fiber lasers given their higher speed, flexibility, precision, reliability, quality and cost attributes. IPG’s geographic split: 44% China, 20% Europe (ex Germany), 12% North America, 8% Germany.

Investment Thesis:
  1. Strong Competitive Position: IPG is the pioneer of fiber lasers and holds the #1 market share (~65%). The company invented the technology and its technological know-how, continual innovation, vertical integration and scale are high barriers for competitors. Their leadership position is evident in peer-leading margins and high/stable return on equity.

  2. Favourable Demand Drivers: Market dynamics are favourable with fiber laser adoption <20% in most applications. 2017 was seen as an inflection point for adoption with the fiber laser industry growing 56% and estimates are for the industry to grow at a 15% CAGR over the next 5 years. Drivers include the displacement of conventional technologies (laser cutting and welding is typically 5-10x faster, and operating costs 20-50% lower, than conventional methods), increasing affordability with 10-20% annual price deflation (akin to the accelerated adoption of semiconductors as prices decreased), and integration of laser with other automation technologies (plays into miniaturization and materials processing trends).

  3. Compelling Entry Point: The stock is off nearly 40% from its recent high on cycle (China/trade) and competitive concerns. While it is possible that we are early in our timing, we ultimately believe that IPGs competitive position is stronger than what the market is giving it credit for and that any slowing in adoption due to trade concerns is merely a pause in demand rather than lost demand. The last recession is a great example of this where operating income dropped 80% in 2009 only to rebound by 800% in 2010 to surpass its 2008 high by 40%. IPGP [at the time of writing] trades at 12x on an ev/ebit basis versus 18.6x for the S&P 500, which seems compelling given the company’s strong secular drivers and deep competitive moat. Looking at IPGs automation peers, at 19.5x earnings, the stock is trading at a ~27% discount. Two analysts recently upgraded IPG to a ‘strong buy’. Additionally, IPG has $1 Billion of cash on the balance sheet (~45% of assets) with minimal offsetting debt and the management team owns 30% of the company.

Portfolio Deletions

Whirlpool (WHR-us), Stantec (STN), SunOpta (SOY)

All three of these companies have been under-performing our expectations. In WHR’s case, there have been several issues: margins are well below target in Europe and Asia; Latin America continues to experience challenges; and the bright spot, volume in North America, seems to be reversing. We have given this name a long leash given what they accomplished with the Maytag acquisition but the competitive environment has become too dire and it seems there is no end in sight. Stantec is in the process of selling its construction business which has produced significant operating losses since we purchased the name, causing management to change its tune (originally management stated it was committed to construction given customer’s shifting preference to integrated providers). Our strategy for the portfolio is to barbell into higher quality names such as those stocks that we have purchased recently (IPG, SPGI, ANSS), hold onto names that seem overly beat up (CLS, ABC, TSN, DLPH, LCII) or are in early cycle recoveries (EFX, BDT, SCL) and remove stocks sitting in the middle. STN is one of those in the middle. SunOpta’s management team tells a good story. Unfortunately, improved financial performance has failed to materialize (it has actually gotten worse). This was a turnaround story and while results are expected to improve starting this upcoming quarter, there seems to be too much that is outside of management’s control.


Trade: This is the biggest fear in markets today and is a big overhang on those companies most exposed. We have done well historically to buy into political uncertainty and while nobody knows how trade will ultimately play out (the recent NAFTA deal is a positive step), our focus on quality management teams should work well as these are most likely to be successful in navigating uncertain times.

Cost Inflation: Input cost inflation is pressuring many stocks. LCI Industries (LCII-us), for example, is down 28% in 2018 through August, despite revenue growth of 30% over the last twelve months. The ability of companies to pass through higher costs will determine how strong their competitive positioning is within their respective markets.

Canadian Energy: An interesting note from Peyto CEO, Darren Gee. He sees the ruling on the TMX pipeline as “just another in a long list of reasons why Alberta should be seriously considering whether it should remain part of Canada. If we were Quebec, we’d have had a national referendum long ago.” Canadian energy is seeing renewed pressure, with lack of offtake capacity continuing to challenge price differentials. Suncor, (SU-T), is largely immune from high differentials given its integrated business model.

Investor Sentiment: Stock market cycles tend to come with emotional footprints. Market bottoms are consumed by fear while market tops come with extreme enthusiasm. We are often in contact with individual investors and have noticed a shift in sentiment over the last several months: questions of "How long will this market last?" (fear of loss) have shifted to "Why don't we own the 'hot' stocks?" (fear of missing out). Chasing returns, throwing in the towel in waiting for a correction to deploy cash, taking money from fixed income allocations (which have produced tiny returns) to stocks - these are all signs that enthusiasm is starting to win over fear. This is not a call on a market top - we would not be so bold to do that - but an indication that this current market cycle continues to mature and investors should prepare for lower returns going forward than what has been achieved in recent years.

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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