CBF Commentary – July/ August 2015

Caldwell North American Equity Strategy – Monthly Update July/August 2015

Portfolio Additions

Robert Half (RHI-us)

About the Company: Robert Half is a temporary and permanent staffing and consulting company focused on providing high-skilled labor to medium-sized businesses, mainly in the U.S. Its major staffing silos include finance & accounting, audit & risk management and technology.

Investment Thesis: Given the skilled nature of Robert Half’s staffing silos, these areas have much tighter labor conditions than the overall U.S. economy. Wage inflation in these areas is improving, which benefits Robert Half, and yet the economy has enough uncertainty that temporary staffing remains in demand. Robert Half is a very well managed business with high teens / low 20s return on equity over a long period. Twenty percent of its balance sheet is in cash with no offsetting debt and operations spin off attractive cash flow. Revenue growth over the last twelve months is 11% and we expect demand for the company’s services to remain robust.

Cardinal Health (CAH-us)

About the Company: Cardinal Health is the 3rd largest distributor of pharmaceuticals and medical devices in the U.S. It is benefiting from growth in drug/medical usage and has additional growth opportunities from the changing health care landscape.

Investment Thesis: We see an attractive cash flow base that has good opportunity to grow and drive value. The health care landscape is changing and Cardinal has been using its healthy balance sheet to acquire assets around key growth areas. These include generics, specialty, alternate sites of care (pharmacy and home), undercutting high-cost medical devices to lower a hospital’s cost of care and international opportunities. We also like the risk profile of a distributor as it gives us exposure to growing drug/medical usage without the binomial risk exposure (i.e. home run or strikeout) of many pharmaceutical and biotech companies.

Portfolio Deletions

Verisign (VRSN-us)

Reason We Sold the Stock: We sold Verisign after a strong earnings report. The upside in shares seemed to be driven by an announcement that Verisign has found a way to bypass approval and launch new domain names on behalf of customers earlier than expected. No details were given other than the contracts would have more flexibility than the .com and .net contracts and the suggestion that they could therefore be more lucrative. We sold into the news as the valuation is nearing our target and we would like to see execution of this new revenue stream before accepting the enthusiasm.

Quebecor (QBR.B-t)

Reason We Sold the Stock: We sold Quebecor as we increasingly focus the portfolio on growth and cash flow generation. We see better opportunities in other names.

Market Update

Stepping Back from Individual Stocks (only for a moment)

We focus these monthlies on the individual companies we own on behalf of clients. Emotions impact how well (or not) investors do in the market and we believe that looking at investing as the ownership of real companies provides a valuable perspective when markets turn down and start influencing investor emotions. However, investors may find it helpful to spend a few minutes reviewing the high level factors driving the market.

China: Turbulence in Shifting from Infrastructure to Consumer Driven Growth

Volatility often occurs when the market is trying to digest a new reality. There are many moving parts to the global economic and corporate earnings picture the market is currently digesting, including the instability of European geo-politics, severe declines in energy and other commodity prices, significant foreign exchange movements, high emerging market debt levels, and questions around China’s growth. The market is particularly responding to the issues in China as its economy has grown to become nearly equal in size to the U.S. While infrastructure development has driven much of China’s growth in the last decade, the country is working to shift from infrastructure to consumer led growth. This is no small task. Whereas a small group of people can drive billions of dollars of spend on a single infrastructure project, consumer led growth means the entire population needs confidence to spend. Given China’s size, this shift is being (and will continue to be) felt by the entire world.

Zero Interest Rate Policies

Central banks around the world have adopted highly accommodative policies in response to the lack of economic growth. The thought is that, if the cost of money is cheap, individuals and businesses will be more willing to spend it, thus creating growth. Despite aggressive measures, growth has been elusive. [Perhaps this should not be surprising. Much of the growth the world has seen was debt driven. Debt is a helpful tool when used to invest in an asset – something that can grow in value over time. However, when debt is used by people to buy stuff – boats, clothes, vacations, home renovations – the effect is to take future spend and bring it into the present. The present was yesterday and the future is today, meaning the world has already spent the money it is currently earning, leaving little to drive growth today. But we digress]. The point is, very low interest rates and the corresponding rise in equity market valuations to historically high levels means investor returns will be less robust going forward. There is also nothing to suggest broad based growth will resume. That is today’s reality.

Our Game Plan In Today’s Reality (back to individual stocks)

We often talk about the competitive advantages of having a concentrated portfolio (approximately 25 stocks) with high active share. This means our stocks are focused on where we see the most attractive risk-adjusted returns. These advantages become increasingly important in today’s reality. Company performance this past earnings season confirmed that growth is slowing and is less broad based, more focused. Our view is that growth will become an increasingly scarce commodity and therefore expect it to start commanding a higher premium to the overall market. This is where we see the greatest opportunity and value today – focusing on high quality, well managed companies that have a solid cash flow yield and clear opportunities to grow and drive value. We have already begun shifting the portfolio to these types of names over the past six months and our goal is to become increasingly selective and focused.

We appreciate your continued support. Feel free to reach out to us at any time.

Best Regards,
Investment Management Team