Viemed, Questor and Magna were the bright spots in what was a fairly uneventful start to the year. With the market undecided as to which direction it wants to go, I maintain my hedge but use up most of my remaining cash to add 4 new holdings to the portfolio.
After a powerful rally in 2017, the markets topped out in January and have been lurching up and down ever since. The Russell 2000, spurred on by the dramatic drop in tax rates south of the border managed to reclaim its lost ground and is now trading near its highs from January. The larger cap S&P 500 is still down about 5% from its highs and seems to be undecided as to which way it wants to go next. The Canadian markets have also been weak, with prices down 5% from their highs of January and flat from the start of the year.
My portfolio has performed roughly in line with the markets, trading down a couple of percent from the start of the year. There were a few big winners (Viemed, Questor, Magna) and some notable faceplants (Assure Holdings).
The overall market continues to look very expensive when compared to historical norms, although the profit boost caused by the tax cuts in the US will bring down valuations there from nosebleed levels to merely very high. Valuations in Canada are similar with stocks on both sides of the border trading at around 20 times earnings and it is difficult for a dyed-in-the-wool value investor to get too excited about market prospects against this sobering backdrop.
Nonetheless, as always, the future direction of the market remains shrouded in uncertainty. While a generally downward direction seems the most likely outcome at this juncture, the possibility of continued gains can’t be dismissed. After years of weak growth, the global economy finally seems to be gaining some traction. While not a full-blown recession, the last few years could be described as an economic slump or slowdown. Perhaps this was enough to hit the reset button and we are now in for a few years of robust, worldwide, coordinated economic growth. That is the narrative that keeps people buying. If earnings were to continue to rise sharply over the next few years, this could keep stock prices elevated and even moving higher irrespective of the currently high valuations.
To me, this seems like an awfully optimistic way to view the current state of affairs and I certainly wouldn’t bet the farm on this outcome, so I am hanging on to my S&P Put options as a hedge against a big market plunge. But with the downside risks taken care of (I hope), this leaves me free to be aggressively optimistic with the remainder of my portfolio. I used up the last of my cash reserves this winter to buy four exciting new holdings: Viemed Healthcare, Atlas Engineered Products, Cervus Equipment and Big Lots. In order to raise additional funds for the new purchases, I also bid a reluctant adieu to a long time holding: Supremex.
I first bought Supremex back in the fall of 2014 at an average price of $2.75 per share. I rode it all the way up to $6.00 a share and then back down to below $4.00. While I made a decent enough profit on this stock, considering the time I owned the company for, it was not one of my more illustrious holdings. I owned this stock in the hopes that they would be able to pivot from the slowly declining envelope business to the more promising packaging business. And indeed, the prospects for this were looking good for a while. But with the latest set of results, I lost confidence in this strategy as the envelope industry seems to be declining faster than Supremex can make up for it with new packaging sales. With their debt levels growing beyond what I feel comfortable with, I decided it was time to move on and sold my Supremex shares. I will still follow this company and perhaps they will ultimately be successful in transitioning their business. If so, maybe this will make an encore appearance in the portfolio at some future date.
Here is how the rest of the portfolio breaks down. As always, both challenges and opportunities abound. I am excited by the names I have in my portfolio. They cover a range of industries and all look to me to be under priced, some by quite a large margin.
Auto Parts
Linamar and Magna are my two big auto parts makers. The auto industry is facing a number of big potential changes. There are going to be a slew of new electric models coming in to dealership showrooms over the next few years. Will consumers embrace this new mode of transportation? Or, as is often the case, will this new technology be slower to catch on than expected? As government subsidies run out, will the new electric cars be cheap enough to effectively compete with the traditional gas guzzlers? Either way, Linamar and Magna aren’t sitting still as this potential sea change washes over the industry. They are both pursuing business in the electric car industry. Magna has been contracted to build the new Jaguar iPace electric vehicle which has been getting a lot of hype as a potential Tesla competitor. Car and Driver calls it “a car worth waiting for”. Magna has also been aggressively developing expertise in driverless technology as well, partnering with Lyft and establishing a separate division to tackle this new field. This could pay big dividends down the road. Finally, Linamar made a big move into agricultural equipment with its acquisition of MacDon earlier this year and together with the strong performance of their scissor lift division, this should help to insulate them somewhat from a potential downturn in the auto sector.
Magna CEO Don Walker had this to say in the most recent quarterly update:
“We had a strong start to the year, reporting record first quarter results and increasing our outlook for sales and earnings. We continue to position Magna for the emerging mobility ecosystem as demonstrated by the recently announced partnership with Lyft.”
And over at Linamar, CEO Linda Hasenfratz said
“We are thrilled with another quarter of record sales growing in double digits and record levels of content per vehicle in every region. We are particularly happy to see double-digit operating earnings growth as well despite lower markets in North American automotive and unfavourable exchange rate changes. The key to continuing our strong performance is an intense focus on new business wins which we are delivering on in spades in the most opportunistic sourcing environment in the automotive sector we have ever seen. Concurrently, excellent growth opportunities in robust markets for our Skyjack and MacDon businesses is painting an excellent picture of global prosperity for Linamar in the future.”
Well, well. Tell us how you really feel!
Investors are nervous that consumer demand for autos could take a big hit in the next recession after years of strong growth. The NAFTA negotiations continue to rage on with no apparent end in sight. But Linamar and Magna both have long histories of profitable growth behind them, they are large, globally diversified players and you can buy these stocks for p/e ratios that are half of what the average company is trading at. I continue to have high hopes for these two companies.
Energy
I currently own 4 different oil and gas service stocks. After collapsing from a price of over $100 a barrel down to the high $20’s, the price of oil has recovered dramatically in the past year, rising back up to the $70 level recently. Unfortunately, this has not been quite the windfall for several of my oil and gas service stocks that I was hoping for. Canadian oil remains land-locked. Without enough pipeline capacity to bring it to market, the price of Canadian crude often trades at a big discount to what drillers south of the border are getting. As well, the jewels of the Canadian industry, the big oil sands projects that were built when the price of oil was riding high, look much less attractive at these reduced prices. These two factors are conspiring to cast a heavy pall over the Canadian industry even as activity south of the border starts to recover.
Amongst my four oil and gas service stocks, Questor Technologies is the star performer. The price is up 36% year to date and a healthy 433% from where I first bought it in 2015. They have been doing very well renting out their growing fleet of waste gas incineration units to customers in Colorado and see this success continuing in the future. They are hopeful that other states could adopt the same sort of environmental regulations that have been providing the strong demand for their services in Colorado.
The other three service stocks have not fared nearly as well and the stock prices have been languishing. Macro Enterprises, PHX Energy Services and Essential Energy Services are all losing money in this environment and are trading below their tangible book value. They all have the potential for impressive rebounds if activity and sentiment improves in the oil sector but it is quite likely we won’t see a full recovery to previous highs, especially if the oil price also fails to fully recover.
For the time being, I am hanging on to my more speculative, smaller positions in these companies, waiting for more clarity on how the oil story will ultimately play out. I won’t wait forever, though. If these companies can’t make money with oil at $70 a barrel, one starts to wonder if or when they will ever make money. There are still some reasons for optimism, though. Macro Enterprises got some good news recently when the Canadian government decided to take over ownership of the Trans Mountain pipeline project (Macro was retained to do some significant work on this project if it ever gets off the ground) and the company still has a big whack of cash sitting in their bank account. PHX Energy says it is enjoying strong demand for its new line of advanced drilling rigs and recently announced plans to start up a high-performance drilling motor division. And Essential Energy is just really darn cheap, trading at only half of tangible book value.
Agriculture
Together, Rocky Mountain Dealerships and Cervus Equipment comprise an essential duopoly in western Canada. They both sell heavy agricultural equipment. Rocky Mountain specializes in Case New Holland and Cervus carries John Deere. While Q1 was a little slower than expected for both companies, which they blamed on a late start to the seeding season, the outlook seems positive after several years of weakness in the industry. I don’t know how the recent reports of drought-like conditions will weigh on results this year, but longer term, I like the outlook for these companies and also for the newly acquired MacDon agricultural equipment division at Linamar.
Garrett Ganden, CEO of Rocky Mountain recently had this to say,
“We have spent the last five years protecting and strengthening our foundations while our industry contracted, and the last three years integrating the 19 acquisitions that drove our revenues to the billion-dollar level. Now that the industry has normalized, and after integrating our previous acquisitions, we are now ready to turn our attention to accretive growth armed with a sound integration framework. But our growth will not just be driven through acquisitions: The strong market of the Canadian Prairies is expected to add $200-million organically through our current geographic footprint and assets.”
Sounds good to me. Let’s hope they can make hay while the sun shines.
Healthcare
The saga at Assure Holdings continues to unfold. Stock trading has been halted since March when the company first warned of irregularities. In subsequent news releases, it was revealed that the CEO had been using the company credit card for his own personal use. He has since been demoted to head of sales and a new CEO with experience running a number of other small cap companies has taken over. While this seems like a move in the right direction, it remains to be seen what the financials will look like after they have been cleaned up by the new auditors. They have said they will be releasing these results soon and when they do, I’ll be evaluating this stock to see if I want to continue holding it or sell it and move on to greener pastures. The company appeared to be on a roll before this scandal blew up. Can they regain their lost momentum?
In comparison, the story at Viemed Healthcare is developing in a much more positive direction. Since buying this stock back in March, the price has risen over 45%. The company completed its medicare audit and said it had received the money that had been held back pending this review. They reported a strong first quarter and received some new analyst coverage. The company also graduated from the venture exchange over to the main board. I remain nervous about their reliance on a single billing code, but as long as the billing structure remains unchanged, the future is looking good for Viemed.
Housing
As the Calgary housing market slowly recovers from the shock of the oil price decline, Melcor continues to execute well. They have remained solidly profitable throughout the oil bust and in their latest quarterly report were sounding quite upbeat. The stock is nonetheless still trading at only half of tangible book value which looks like a bargain to me.
The investment thesis is not so cut and dried with Atlas Engineered Products. This was a recent addition to the portfolio and is a very small, very early-stage company attempting to roll up the building truss market. The idea seems solid; buy up small, regional truss manufacturers at very attractive prices and roll them into a larger company with national reach, enjoying economies of scale and benefits from applying best practices to the newly acquired regional players. Whether they can execute on this vision without stumbling remains to be seen and I have only dipped my toe in the building truss market with a small position in this potential up and comer.
Consumer Discretionary
I’ll lump Westjet, GoEasy and another new acquisition, Big Lots, together into this category. There are not a lot of retailers to choose from in the Canadian markets, so I was pleased to stumble across Big Lots in doing a review of the US markets. They have a stable, long term track record and can be bought for only 8 times their projected earnings this year. It seems to me like their discount and liquidation business could be somewhat recession resistant which appeals to me at this potentially late stage in the business cycle and their debt levels are quite modest compared to many retailers. Their most recent quarterly results were a bit of a disappointment with same store sales down 3% but I am not going to get spooked out of my position at this early stage. Hopefully the softness in the first quarter does not presage a more precipitous decline in their fortunes but we will have to see how the rest of the year plays out.
Westjet has also had more than its fair share of difficulties this winter. Soaring oil prices have been a blow to their bottom line and the recent labour negotiations with their pilot’s union took a toll on customer bookings. Analysts are concerned that they will be challenged to execute smoothly on the roll-out of their ultra low-cost carrier this summer. All legitimate concerns which have knocked the stock price down a peg or two, but with a trailing p:e ratio of around 8, I remain enamoured of their longer term prospects and am happy to give them the benefit of the doubt as I hold on for clearer skies ahead.
GoEasy had a good start to the year in 2018. The share price is up around 10% year to date. Q1 was quite healthy with a big increase in their loan book and record loan originations during the quarter. Defaults were lower and their collection rate improved. The company benefitted from their expansion into Quebec and their new secured loan product. David Ingram, the CEO, reports,
“We are delighted to see that the positive momentum from our performance in 2017 has accelerated in the first quarter of 2018. With our highest loan book growth in a single quarter and our lowest net charge off rate since 2014, our confidence in the business and our ability to achieve our targets has never been stronger. The execution of our strategy, coupled with our focus on helping our customers rebuild their credit, are working well as we also saw net customer growth increase 70% over Q1 2017.”
Trading at still attractive valuations given its strong growth outlook, this remains one of my top holdings.
And The Rest
Difference Capital and Geodrill round out the roll call. I’m maintaining my small holding in Difference Capital in the hope that the very large discount to book value will diminish at some point and hopefully because the share price has risen, not because the book value of their investments has deteriorated!
Geodrill looks quite attractive to me. With a stable gold price, they have been enjoying robust results with their African drilling operations. Earnings were very strong in Q1, almost back to their peak levels from 2011 and 2012 when gold was trading at $1700 an ounce. Since then, they have added significantly to their drilling rig fleet and their outlook is upbeat. Dave Harper, the CEO, has this to say,
“Our dedication to customer service and safety, with well-established miners and exploration companies in West Africa, continues to drive business, as evidenced by our overall results, including the increase in metres drilled. Our new increased banking facilities will allow us to continue to finance our growth and capitalize on any potential opportunities that arise. Looking forward, with all of the elements in place to both maintain organic growth and capture market share growth, we will focus on maintaining solid margins while keeping pace with strong drilling activity in West Africa.”
With a trailing p/e under 10 and a rock solid balance sheet, this stock looks well positioned to succeed as long as the price of gold remains steady. If the gold bugs are proven right and the price of gold vaults higher then this company could do even better.
Conclusion
Overall, a relatively underwhelming start to the year for the portfolio with both hits and misses. But I am very happy with the companies that I own. There are many that look extremely undervalued when compared to the high prices seen elsewhere in the markets and it is with the usual mix of mild apprehension and excited optimism that I look forward to the rest of the year.
Full disclosure: I own shares in Assure Holdings, Atlas Engineered Products, Big Lots, Cervus Equipment, Difference Capital, Essential Energy Services, Geodrill, GoEasy, Linamar, Macro Enterprises, Magna International, Melcor Developments, PHX Energy Services, Questor Technologies, Rocky Mountain Dealerships, Viemed Healthcare, Westjet and put options on SPY.