December 2016 | Caldwell Balanced Fund Commentary

Caldwell Balanced Fund Update December 2016

Contents:

Portfolio Additions: Apogee Enterprises (APOG)

Portfolio Deletions: Varian Medical (VAR), CSX Corp (CSX)

Company Updates & Market Commentary:

   – CCL Industries

   – A Brief Review of 2016 & Looking Forward

News

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Portfolio Additions

Apogee Enterprises (APOG)

About the Company: Apogee is a leading fabricator of coated, high-performance architectural glass which provides color, energy efficiency, hurricane/security protection and sound control primarily to commercial and institutional buildings. Its related architectural framing systems businesses design and build the aluminum frames for windows, curtainwall and storefront systems that comprise the outside skin of buildings (which hold the glass). It also provides installation for its products. Nearly 95% of revenue is generated in the U.S. but notable projects in Canada include the Bay Adelaide Center and First Canadian Place (rejuvenation) in Toronto.

Investment Thesis: Apogee is a leader in its industry with 70% market share in the 10 storey and higher market. The company brought in a new CEO in 2011 and has since replaced the leaders in 5 of its 7 business units. The team has a strong operational focus and has done an excellent job of improving margins, which have started to benefit from a pick-up in industry activity. Because Apogee is the only fabricator in North America that makes its own coatings, it works closely with architects in the design phase, which gives them good visibility into future projects. The team is also expanding into adjacent markets (lower storey buildings, rejuvenation projects, consolidating the fragmented framing market) which should provide good growth opportunity and make for less volatility through the cycle. The company is in a strong balance sheet position to drive this growth.

Notwithstanding these improvements to the business driven by the new team, there seems to be a healthy amount of skepticism around how well the business can perform through the cycle. It also seems that the market is underappreciating the company’s visibility into future projects. We view this as an opportunity and expect shares to benefit from both earnings growth and (valuation) multiple expansion.

Portfolio Deletions

CSX Corp (CSX)

Reason We Sold: This is the 2nd time in just a few months that a company has moved significantly higher just weeks after we sold it. The stock’s valuation had increased to historical highs after a strong run in its share price and we sold it into the concern that margins on the back of cost cuts won’t necessarily hold in a higher volume environment (something we had witnessed in 2014). While this past quarter’s results affirmed our call, it was subsequently announced that an activist investor was looking to replace CSX’s CEO with an industry veteran who successfully transformed one of CSX’s peers. While we are not happy campers about the timing of the sale, the positive is that we are clearly identifying value and this should translate into good performance for our clients over time.

Varian Medical (VAR)

Reason We Sold: We exited half of our position in late October on rumors of a GE takeover (those rumors never turned into reality), and sold the remaining position in late December. Varian is going through the process of splitting its company in two – an oncology company and a imaging company. We thought this process would keep the shares range-bound and thought investors would be better off in Apogee.

Company Updates & Market Commentary

CCL Industries

CCL Industries, a global leader in label technology, announced an acquisition of a company that specializes in films for labels, packaging and security applications. The acquisition is both highly accretive (CCL paid an attractive price) and transforms the company by adding high-value security technology that can be embedded into CCL’s existing label offerings. The deal will increase the company’s operating earnings by approximately 18% and we expect some cost synergy and cross sell opportunity to drive additional growth.

A Brief Review of 2016 & Looking Forward

It is said that markets climb a wall of worry, and that was certainly the case in 2016. After a shaky start (both the S&P 500 and TSX were down 11% in the first few weeks of the year), markets battled through political uncertainty (Brexit, impeachments, failed coups, the U.S. election), wars/terrorist events, and economic uncertainty (negative interest rates) to regain early losses and end the year on a strong note. Strength in commodities was the major story and this drove the Canadian market to outsized returns versus the rest of the world. Indeed, if one strips out the volatile Energy and Materials sectors, Canada’s market return would be cut in half.

Here is a summary of what drove the portfolio’s performance in 2016:

Top Contributors:
1) an underweight position to the yield-sensitive Consumer Defensive and Real Estate sectors
2) security selection in Technology (Mentor)
3) security selection in Consumer Cyclicals (Whirlpool, Omnicom and CCL)

Top Individual Contributors: Mentor Graphics (sold on Nov 1), CSX (sold on Dec 23), Parkland, Broadridge, Suncor

Bottom Contributors:
1) underweighting the Canadian market which benefitted from a strong commodity rally
2) an underweight position in Basic Materials (i.e. commodities)
3) an overweight position in Consumer Cyclicals
4) security selection in Financials (light exposure to Canadian banks) and Industrials (Bird Construction)

Bottom Individual Companies: Cardinal Health, Bird Construction, Cognizant Technologies, Celestica, Williams Sonoma

The market’s focus has shifted to President Trump and his policies. On one hand, if he is successful in bringing down regulatory burdens, there can be significant benefit to economic growth. Investment decisions at the corporate level are driven by project IRR (the return on the capital invested in this project). Regulations generally weigh on IRR by increasing the cost and delaying the benefit of projects. If more efficient regulation can decrease the amount of time required to get a project started, or decrease the cost of the project, then more projects will qualify for investment, which would be good for economic growth. On the other hand, protectionist policies have negative outcomes and it is unclear sitting here today which policies will have the bigger impact. Ultimately, we look for management teams that can find ways to continue to grow the value of their businesses over time, regardless of what the political environment throws at them.

We appreciate your continued support.

Best Regards,
Portfolio Management Team