CBF Commentary – January & February 2016

Caldwell Balanced Fund CBF Update – Jan and Feb 2016

Portfolio Additions:

One of the additions to CBF was

Williams-Sonoma (WSM-us):

About the Company: Williams-Sonoma (WSM) is a multi-channel specialty retailer of home products, operating through the Williams-Sonoma, Pottery Barn, West Elm, Rejuvenation and Mark and Graham brands. Ninety-five percent of revenue is generated in the U.S.

CBF Investment Thesis:

The stock sold off over 40% from its August peak. The sell off appears to be driven by weakness in overall retail sales, plus company-specific concerns on higher expenses related to lingering inventory repositioning following the west coast port strikes. We believe the sell off presents a buying opportunity for the following reasons:

1) The stock is attractively valued no matter which way one looks at it. Specifically, it is in the cheapest 10% of our investable universe yet has growth rates within the top 40%. It trades at a 30%+ discount to its 10 year average multiple, a 40%+ discount to the S&P 500 and a 30%+ discount to home retail peers.

2) While many retail stocks have showed sluggish growth, WSM is growing quite well, having increased revenue 6.7% over the last 4 quarters and posting same-store-sales growth of 4.5% this past quarter.

3) WSM sells into a segment of the economy that is showing strength: housing. Furniture/home furnishing sales grew 6% in 2015 and the outlook seems promising given housing starts and new permit growth of 10%. Additional growth opportunity exists from a fragmented home furnishings market.

4) While higher expenses from the port strike have lingered longer than investors would have liked, higher expenses seem temporary. Much of the expense comes from higher shipping costs given a geographic mismatch of inventory to demand, which is more noticeable given the size and weight of furniture. We think management’s position to keep customer satisfaction high through on-time deliveries makes sense beyond the near term costs. Most importantly, demand remains strong.

5) WSM is a well run company with mid teen return on equity. The company remained profitable through the recession and there is currently no debt on the balance sheet.

6) Those analysts that remain cautious view the stock favorably beyond the near term.

Portfolio Deletions

W.W. Grainger (GWW-us) Reason We Sold the Stock: While the original ‘scale’ thesis on GWW remains intact, we were premature in the timing of our purchase as industrial trends continue to be weak on declining capital investment in energy and resources, and the stronger U.S. currency affecting demand for U.S. goods.

Market Commentary

2016 Begins in Risk-Off Mode After a decade-long investment into growing the supply of energy and materials, much of which was required to support China’s infrastructure and export-led growth, the global economy finds itself in the process of adjusting. The world now seems to have enough resources, especially as China shifts to consumer-led growth, and the economic growth that was driven by this investment must be replaced with another source of growth.

Caldwell Balanced Fund Update CBF

While this adjustment in itself is a source of uncertainty (and remember, markets hate uncertainty), the world is also facing the hangover of misallocated capital, particularly as it pertains to bad decisions that were funded with debt (think of the energy companies that used debt to buy land that can no longer profitably produce oil, or the massive amount of unprofitable steel production capacity in China). Because many of these projects were funded with debt, somebody is facing the prospect of not getting paid back. Faced with this uncertainty, investors in credit (i.e. debt) markets have started requiring higher rates of return, resulting in credit spreads widening . Concerns of how resource-related weakness might filter into other parts of the economy has also spread to equity markets, causing stocks to sell off. While central banks are continuing to keep interest rates low in an attempt to stimulate growth, confidence in their ability to succeed is waning

The broad-based risk-off nature of the market becomes apparent when identifying the business sectors that have recently performed well. Consumer Staples, Telecom and Utilities (businesses with earnings that are less affected by economic recessions), along with gold (often considered a safe-haven for investors) are the only sectors that have posted positive returns this year. This is true in both the Canadian and U.S. market, showing that the risk-off sentiment is widespread.

Corporate earnings and commentaries,

however, have not been as bad as the risk-off mode of markets suggests. Looking at something as economically-sensitive as airline demand, we noticed that every major U.S. airline spoke positively on the demandenvironment.As we have said in the past, however, growth is slowing across many business sectors and geographies and is increasingly harder for corporations to come by.Given this low growth environment, we believe investors must be focused in where they allocate cash. This speaks to actively-managed over passive portfolios. Looking to our portfolio specifically, we are focused in the following areas for CBF:

  • A low growth world means a competitive world. As such, much of our portfolio is focused on companies that help other companies become more competitive [Omnicom (through marketing), Celestica (through manufacturing), Robert Half (through staffing), Accenture, Broadridge, Cognizant and Amdocs (through business strategy via technology)
  • Broad-based ‘risk-off’ environments create investment opportunities. Onex and KKRhave a strong history of making good investments and will be planting the seeds today to drive performance fees and shareholder value going forward
  • Companies that can use scale to their advantage, such as Parkland Fuel and CCL Industries.
  • Companies participating in the strongest parts of consumer spending [Whirlpool and Williams Sonoma to the current strength in housing and Varian Medical and Cardinal Health to the long term, demographic-driven demand for health care].

Looking beyond the current uncertainty, we ultimately believe low resource prices will be a net benefit to global economic growth. While the transition period will come with its fair share of uncertainty (and therefore market volatility), the worldwill adjust and find new places to drive growth. This is another reason we like the U.S. market, as this ultimately speaks toinnovation, which the U.S. is particularly strong at

We appreciate your continued support.

Best Regards, Caldwell Investment Portfolio CBF Management Team


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