Balanced Fund Report

December 2018 | Caldwell Balanced Fund Commentary

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The market’s behavior in the 4th quarter (“Q4”) of 2018 was downright ugly. The S&P 500 in the U.S. was down 13.7% in Q4 (with a peak to trough decline of ~20%) for a full year return of -6.2%. This was the S&P 500’s worst quarterly decline since Q3 2011 and only 8 of the 72 quarters since the turn of the century have experienced greater losses. In Canada, the S&P/TSX Composite was down 10.9% in Q4 (with a peak to trough decline of ~16 %) for a full year return of -11.6%.

 

The investment industry spends a lot of time attempting to explain “what happened.” Trump, trade, interest rates, central bank balance sheets, credit spreads, Brexit, global debt levels, recession risks, etc. But why now?

 

To be clear, corporate earnings were very strong in 2018. S&P 500 revenue growth was 9% while earnings grew 20%, partly aided by tax cuts. Economic growth continues to be strong with the following comments coming from CEOs of some of the companies closest to main street:

 

Delta Airlines (the largest airline in the US), Q3 Earnings Call: October 11, 2018
“The revenue environment is the best we’ve seen in years…”

 

JP Morgan (the largest diversified bank in the US), Q3 Earnings Call: October 12, 2018
” I would say that as we look at the economy, we don’t see it slowing down. It seems to be continuing to grow pretty solidly.”

 

Robert Half (a leading U.S. staffing agency): Q3 Earnings Call: October 23, 2018
“I’d say, so far, the sentiment does remain quite strong, as does confidence. Trade issues and higher rates have not yet trickled into the conversations we have with clients or their buying habits. So, so far, so good. There’s no question, given our results, given our data, the underlying U.S. economy is quite strong, particularly for small to middle-size businesses.”

 

As you can see, these comments were made not that long ago. So, what happened? As Howard Marks points out in his timely book, “Mastering the Market Cycle,” nothing in the economy changes that dramatically in only 3 months. And while corporate probability has greater ebbs and flows than the economic cycle, even corporate fundamentals don’t change that quickly. That brings us to the market cycle, which is the most volatile because it is driven by human emotion.

 

Sure, some of these, like trade, have escalated recently. Trade frictions have eroded confidence in China which has slowed growth there. The fear, it seems, is that slower growth will permeate across borders and into the U.S. and globally. There is also the concern that, given economies are built on confidence, the market’s decline in anticipation of a global economic slowdown will become a self-fulfilling prophecy: businesses and consumers both rein in spending due to the heightened ‘uncertainty.’  However, it seems to us that trade tensions can get resolved just as quickly as they escalated. Central banks will adjust their strategies so as not to jeopardize a recovery. As we have previously discussed, the big headwind to global growth going forward is debt levels. That is why we believe a targeted investment strategy makes the most sense in this environment – investors will no longer be able to fall back on broad based economic or market growth.

 

Taking it down to the portfolio level, our core investment principles have not changed: protect and grow our investors’ capital through discounted valuations, strong balance sheets, good management teams and attractive business environments. Please see Table I for how our portfolio stacks up against our screening universe on key metrics that reflect this strategy. We did well to have more invested in the U.S. over Canada. Canada has now under-performed the U.S. market in 7 of the last 8 years. Canada lacks meaningful exposure to the more relevant Technology and Health Care sectors (Table II) while having over 50% exposure to Energy and Financials. Oil prices were down ~25% in 2018 with heavy discounts on Canadian oil adding to the pain.

 

 

Top performers in the portfolio in 2018 were Keysight Technologies, Mitel Networks and Parkland Fuel. Keysight is the world’s largest electronic measurement company with solutions that enable customers to design, test, and manufacture electronic products. Keysight is benefiting from several secular growth drivers such as the 5G upgrade cycle, the electrification of autos, and the connected vehicle. Mitel Networks is a global provider of business communication services. The stock performed well as they reaped synergies from a large acquisition and continued their transformation to the cloud, with the stock subsequently being acquired by private equity firm Searchlight Capital. Parkland Fuel is Canada’s largest independent marketer and distributor of fuels and petroleum products in Canada. Parkland performed well on the back of two very large and accretive acquisitions. The company continues its consolidation strategy which will further expand its scale advantage.

 

On the other end of the spectrum, the portfolio struggled with companies exposed to the factors listed above – specifically, trade tensions and higher interest rates. Delphi Technologies and LCI Industries were particularly hard hit. Delphi, a tier one powertrain parts supplier, was affected by a worsening auto situation in China and growing pains on the back of strong order bookings as they now need to invest heavily to meet demand. LCI Industries, a supplier to the RV industry, was affected by inventory reductions at the dealer level given the uncertainty around how higher financing rates might impact RV demand.

 

While the quickness and intensity of the market downturn create uneasy feelings for investors, we note that many stocks in our portfolio are trading at all-time low valuations. This suggests that much of the uncertainty is already priced into these stocks. Using history as a guide, the longer one’s time in the market, the better one’s odds of earning a positive return. It is also true that the risk/return profile facing investors today is much more attractive than it was 3 months ago.

 

As always, we appreciate our investors’ support, particularly during these times of market uncertainty.

 

Please feel free to reach out to us at any time.

Best Regards,
Portfolio Management Team

All data is as of January 8, 2019 unless otherwise indicated. The information contained herein provides general information about the Fund at a point in time. Investors are strongly encouraged to consult with a financial advisor and review the Simplified Prospectus and Fund Facts documents carefully prior to making investment decisions about the Fund. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Rates of returns, unless otherwise indicated, are the historical annual compounded 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 unitholder that would have reduced returns.  Mutual funds are not guaranteed; their values change frequently and past performance may not be repeated. Principal distributor: Caldwell Securities Ltd. Publication date: January 8, 2019.

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.

 

Commentary

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.

December 2017 | Caldwell Balanced Fund Commentary

Portfolio Additions

AmerisourceBergen (ABC-us)

About the Company: ABC is the leading pharmaceutical distributor in the U.S. and competes directly with Cardinal Health (CAH).

Investment Thesis: We purchased ABC as a replacement for CAH. In addition to getting a slightly better cash flow yield with ABC, we also get a better balance sheet, better positioning in the higher growth specialty segment, less contractual risk, better management and also remove headwinds form CAH’s medical supplies business. The industry continues to trade at a sizable discount to the market but we believe this gap will close as deflationary trends are improving and the group benefits from the recently-enacted U.S. tax plan.

 

Mitel Networks (MNW-us)

About the Company: Mitel is a leading provider of communication tools to businesses and other organizations (hotels, hospitals, schools, etc). Its focus is on unified communications and collaborations (UCC) which serve to integrate different types of communication tools across different end users, geographies and devices.

Investment Thesis: Mitel trades at a significant discount to the market and peers and we believe the shares can move meaningfully higher as focus shifts from their legacy on-premise to their growing cloud platforms. The 2017 acquisition of Shoretel increased Mitel’s recurring revenue to 40% of total revenue and increased recurring cloud revenue, which is growing at a double-digit pace, from 12% to 20%. Mitel has a large installed base of 60 million on premise users of which only 1.5 million have converted to the cloud model, providing a long runway of cloud growth. We also expect margins and cash flow to significantly improve on the combination of cloud growth, cost initiatives, Shoretel synergies and interest savings.

 

Berry Global (BERY-us)

About the Company: Berry is a leading specialty plastics producer whose products are used in a diverse set of end markets, including the health & personal care, household, food & beverage, food service, industrial and transportation markets.

Investment Thesis: BERY is a leader in the fragmented specialty plastics industry where its scale allows it to be the low cost producer. With $7 billion in revenue within a $200+ billion packaging industry, the company has continued growth runway through a successful acquisition strategy that has resulted in meaningful earnings per share growth. With approximately 2/3 of revenue tied to stable end markets, we expect BERY to provide stability to the portfolio. From a valuation standpoint, we view BERY’s 5% free cash flow yield, which ranks in the top 15% of our screening universe, as attractive.

 

TE Connectivity (TEL-us)

About the Company: TE is the largest global manufacturer of connectors, which protect the flow of power and data inside of millions of products used daily by consumers and industries. It has leadership positions in each major end market -transportation, industrial equipment, energy and consumer – and generates $13 billion in revenue within a $70 billion addressable market. TE does particularly well in ‘harsh environments’ which are characterized by extremes in temperature, pressure and vibration with exposure to fluids. TE also supplies sensors that measure and respond to pressure, temperature, humidity, position, force, vibration and other readings.

Investment Thesis: We expect TE’s growth to accelerate on the back of several secular trends. These include the advancement of safety, efficiency/electrification and connectivity of the auto and other vehicles (TE’s content per vehicle is expected to grow from the low $60s today to over $100 over the next 8 years), continued factory automation and demographic-driven growth in medical devices where TE specializes in minimally invasive procedures. We also expect further margin growth driven by TE’s lean operations model. Despite these strong tailwinds and a high teens return on equity that ranks TE in the top 30% of our screening universe, the stock trades at a slight discount to the S&P500 and generates twice the free cash flow yield of our screening universe.

 

Stantec (STN-t)

About the Company: Stantec is the 3rd largest design firm in North America and provides engineering, architecture, and project management services to Infrastructure (28% of revenue), Buildings (22%), Water (22%), Environmental Services (17%) and Energy & Resources (11%) projects. STN has 22,000 employees and operates in 400+ locations globally.

Investment Thesis: STN is a high quality business that has under-performed peers on the back of oil & gas/resource exposure and several self-inflicted, but temporary (in our view) missteps. We believe these issues are behind the company and several catalysts suggest a higher share price going forward, including: 1) Analyst estimates have been reset lower, thereby reducing the likelihood of additional disappointments; 2) Infrastructure spending is picking up and STN should benefit given its leadership positions in key verticals; 3) Commodity prices have moved higher suggesting STN’s commodity-related verticals have likely seen a bottom; 4) A new CEO helps put recent missteps in the rearview mirror; 5) Renewed acquisition after an extended integration period. At the time of purchase, STN traded at a 5.2% free cash flow yield versus 4.6% and 3.0%, respectively for peers TTEK and WSP despite significantly higher return on equity. Versus our broader screening universe, STN has a higher return on equity, better balance sheet, lower capex requirements, greater profitability, equal to or greater growth opportunity and yet trades at over two times the universe’s free cash flow yield at 5.2%.

 

Delphi Technologies (DLPH-us)

About the Company: Delphi Technologies, a recent spin-out from Delphi Automotive, is a leader in products that optimize a vehicle’s powertrain.

Investment Thesis: DLPH is a best-in-class operator with a long track record of consistent execution and solid market share positioning in each of its major segments. Delphi has strong relationships with most of the major Original Equipment Manufacturers (“OEMs”) and, given its high degree of technical expertise, benefits from high switching costs. The company is well-positioned to benefit from: 1) Regulatory-driven reductions in vehicle emissions; 2) The shift from combustion to hybrid/electric-vehicle (EV) systems (where Delphi carries five times the normal engine content); and 3) A cyclical recovery in commercial truck/aftermarket volumes. We believe these growth opportunities, coupled with margin expansion and a multiple re-rate to reflect its status as a beneficiary of EV systems, will drive the stock price meaningfully higher.

Portfolio Deletions

Cardinal Health (CAH-us)

Reason We Sold: See ABC thesis, above.

 

Robert Half (RHI-us)

Reason We Sold: RHI is up ~50% since the late 2016 lows on speculated (and now confirmed) benefits from U.S. tax reform and a strengthening U.S. economy. Our concerns stem from RHI’s commentary surrounding lengthening conversion cycles and this leads us to wonder if something has structurally changed for the recruiters, particularly as companies like Google and LinkedIn (Microsoft) look to leverage their vast databases. As such, we see better risk/reward in the opportunities added to the portfolio.

 

Apogee (APOG-us)

Reason We Sold: We sold APOG following another weak quarter as our investment thesis is not playing out as expected. Despite favorable end market dynamics and a leadership position in the industry, the pricing environment has become more competitive as its peers look to stem market share losses. While management continues to be positive on the future, they have lost credibility in our minds as previous positive commentary failed to materialize.
 

Kohl’s (KSS-us)

Reason We Sold: We sold KSS into share price strength driven by better traffic results, expected benefit from U.S. tax reform and optimism on its new relationship with Amazon. KSS has struggled with traffic for years, despite management’s sole focus on traffic-driving initiatives, and ultimately, we haven’t seen any evidence that secular headwinds from online shopping will reverse. While the relationship with Amazon may prove to be the initiative that finally gets traffic going, no economics have been provided on the arrangement. We continue to view consumer trends as hard to predict and quick to change and as such, prefer exposure to the companies noted above.

 

Accenture (ACN-us)

Reason We Sold: ACN was a strong performer, +64% since our initial purchase in September 2015 versus +42% and +21% for the S&P 500 and S&P/TSX Composite, respectively. We continue to view ACN’s business favorably and maintain exposure through its peers, Cognizant (CTSH) and CGI Group (GIB.A), both of which are trading lower valuations. We simply needed a source of cash for the opportunities outlined above.

Commentary: 2017 Performance Review & 2018 Outlook

  1. The portfolio being over-weight the Technology sector, which out-performed the broader markets in both the U.S. and Canada;
  2. Security selection in Materials stocks, driven by CCL Industries;
  3. Security selection in Financials stocks, driven by KKR, Citigroup and Onex.

Top detractors included:

  1. Security selection in Technology stocks, driven by Celestica and Amdocs and the lack of exposure to Apple and Facebook;
  2. Security selection in Consumer Discretionary stocks, driven by Omnicom and Whirlpool and the lack of exposure to Amazon;
  3. Security selection in Industrials stocks, drive by Apogee.

 
 
 

Caldwell Balanced Fund Performance 2017

Table 1 - Top and bottom contributors to performance in 2017

One of the more interesting things about 2017 was the apparent shift in investor psychology. Up until the latter part of the year, fear (is this the top? are we headed for another crash?) and disbelief/skepticism (how can markets make new highs with Brexit and Trump), seemed to dominate investor thinking. As markets continued to reach new highs, however, ‘fear of loss’ seemed to shift to ‘fear of missing out.’ It has once again become exciting for people to talk about the markets and the amount of questions and money being thrown at unproven business models in digital currencies and marijuana is telling. While these are signs that the market is closer to a top than a bottom – we buy into the ‘cycle of emotion’ where market bottoms coincide with extreme fear while tops come with extreme exuberance – predicting the timing of when the top will occur is anyone’s guess. This creates difficulty given we live in a world where performance returns are published on a daily basis. Most pundits expected higher volatility in 2017 (an erroneous forecast). That forecast has now shifted into 2018.

 

Our recommendation to investors is to have a conversation with their investment advisors on cash needs. If money is required in the next year or two, it may be wise to lock in some gains.

 

While not evident by performance last year, we continue to believe that a focused portfolio of ~25 stocks targeted at select company-specific opportunities will serve investors well going forward. As outlined above, we have made meaningful changes to the portfolio in the last several months. Studying where we have recently under-performed, while we owned high quality companies trading at attractive valuations, these companies lacked catalysts or growth opportunities to move the share prices higher. This is something we have targeted in the purchases made since this past summer; results on these investments have been encouraging thus far and we look forward to tracking the portfolio’s progress as we move forward.

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.

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.

June 2017 | Caldwell Balanced Fund Commentary

Portfolio Additions

SunOpta (soy-t)

About the Company: SunOpta is a leading provider of organic and non-GMO consumer food and ingredients in North America. Customers include Kirkland (Costco’s private label), McDonalds, Loblaw, Gerber, Cliff Bards, Frito Lay, Blue Diamond, Hain Celestial and Chobani. The business is a product of 30+ acquisitions since 1999 that were never effectively integrated, and recent operational missteps prompted the Board to conduct a strategic review of the business.
Investment Thesis: We expect the share price to move meaningfully higher on the following:

  1. New Management: A new management team has been assembled that includes the appointment of a CEO who recently led a similar turnaround story at another food company. The CEO has brought in individuals who are motivated by opportunity and thrive on accountability and a high performance culture, and designed compensation packages that are aligned with targets set out in the company’s new value creation plan.
  2. Better Operations: The value creation plan involves a 40% profit improvement through cost initiatives alone. We like opportunities where there’s an ability to grow the value of the business without needing a favourable external environment to do so.
  3. Growing End Markets: U.S. organic food sales grew 8.4% in 2016, materially higher than the 0.6% growth in the overall food industry. The growth runway remains attractive as organic accounts for only 5% of total food sales despite growing consumer demand for healthier options.
  4. Competitive Advantage in an Industry-Leading Supply Chain: The supply of organic farms is limited and maintaining the integrity of the organic ingredients supply chain is not easy. Over the last 30 years, SunOpta has built the largest organic sourcing platform in the world and now sources ingredients from 65 countries. It has direct, long-stnding relationships with organic farmers and often helps with the certification process (note that it takes 3 years for a farm to gain the organic certification).
    [Note: SOY was also purchased in our Caldwell Canadian Value Momentum Fund (“CCVMF”). The stock was originally sourced for this mandate but subsequently hit the CCVMF’s buy list].

TFI International (tfii-t)

About the Company: TFII is a leading transportation company in North America, operating in the truckload, package & courier, less-than-truckload and logistics industries. It generates 53% of its revenue from Canada and another 46% from the U.S. The company has a strong track record of growing shareholder value, both organically and through strategic acquisitions and asset monetizations.
Investment Thesis: After rising nearly 30% following the announced acquisition of XPO’s North American assets, a weaker-than-expected earnings report subsequently sent the stock back to pre-acquisition levels, wiping out all of its previous gains. Expectations at the time of the acquisition were for the trucking cycle to recover in late 2017; the expected recovery has now been delayed into 2018. Additionally, under-investment in the acquired company will lead to heightened expenses over the next few years so that deal economics are not as favorable as originally thought. Having said that, the trucking recovery seems like a timing issue and, even after adjusting for higher costs, the deal remains very favorable to TFII shareholders. We believe the shares got ahead of themselves and expectations are now reset. Industry participants are cautiously optimistic that the trucking cycle has seen its bottom and management at TFII have shown a great ability to generate cash from acquired companies. We expect shares to resume moving higher as trucking weakness subsides and as the company begins to unlock value from recently acquired assets.

Keysight Technologies (keys-us)

About the Company: Keysight is the world’s largest electronic measurement company, providing hardware and software solutions that enable its customers to design, test and manufacture electronic products. They have market-leading, 20%+ market share in the Communications, Aerospace/Defense and Industrial Electronic verticals.
Investment Thesis: The company was spun out of Agilent Technologies in 2014 where it acted as a cash cow and received little growth capital. After several years of flat growth, KEYS seems well positioned to benefit from the following secular growth trends: i) 5G deployment: 5G is expected to be rolled out over the next few years as the rapid growth of connected devices and the increasing use of video streaming is driving demand for faster wireless systems. ii) Automotive/Power: the trend towards intelligent/connected cars, and power generation from renewable energy sources (battery power and wind power); iii) the move to software based testing and management. KEYS has mission-critical offerings with high barriers to entry and 50% recurring/repeat revenue. We believe KEYS’ valuation discount to the broader market is unwarranted and expect shares to move higher as growth starts to accelerate.

 

Portfolio Deletions

Quintiles IMS (q-us)

Reason We Sold: We initiated the Q position in November 2016. The forward tev/ebit multiple at that time was 11.7x versus 15.6x today. While the 6 months we held the stock is a relatively short investment period for this strategy, Q is up 25.7% since our initial purchase versus 15% for the S&P500 and 5% for the TSX Index. Given the expansion in the multiple and that the stock is one of the more expensive names in the portfolio, and that there is a bit of uncertainty related to their change in how they report bookings, we have decided to sell the position and re-deploy cash into other opportunities.

 

CCL Industries (ccl.b-t)

Reason We Sold: CCL has done a fantastic job of creating shareholder value through lean operations, extracting synergies from acquisitions, and improving its margin profile by shifting to higher-value add products. We initiated the CCL position in November 2012. The forward tev/ebit multiple at that time was 7.7x versus 18.2x today while EPS has grown from 0.57 to $2.24. This has been the strategy’s most successful position with a 589% return since its initial purchase versus 70% for the S&P500 and 24% for the TSX Index. Given the expansion in the multiple, and that the stock is up nearly 45% since its announced acquisition of Innovia in December 2016, we think a lot of future value creation is already baked into the stock price. As such, we have decided to sell the position and re-deploy cash into other opportunities.

We appreciate your continued support.

Best Regards,
Portfolio Management Team

The information contained in this document is designed to provide you with general information and is not intended to be comprehensive investment advice applicable to the circumstances of an institutional or individual investor. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rate(s) of return is (are) the historical annual compounded total return(s) including changes in (share or unit) value and reinvestment of all (dividends or distributions) and does (do) not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Inception Date: March 1, 1990. Principal Distributor: Caldwell Securities Ltd.