Daniel Lloyd is founder and portfolio manager, Sui Generis Investment Partners. His focus is Canadian equities.
Top Picks:
ZCL Composites (ZCL.TO)
ZCL is the largest manufacturer in North America of fibreglass fuel tanks, largely sold into the retail gas station network. We've owned the name since we launched, and it's exactly the sort of business we love to own in our long book. The company has no debt, a free cash flow yield of 10 per cent, and it should act very defensively if this market begins to act erratically again. The common dividend has been raised by more than 75 per cent over the last year and the company recently paid a 50 cent per share special dividend. With a lot of turnover happening at retail gas stations, there is a very solid pipeline of work for ZCL as new owners tend to worry about the environment liabilities of the assets they've just purchased. Bought at $8.75 on June 16, 2016
*Short* CI Financial (CIX.TO)
The mutual fund business is undergoing seismic changes, and we believe CI stands to be harmed the most of the publicly-traded asset managers. CI's net sales have turned negative this year, the performance of their funds has been particularly weak (which explains the weak sales), and the valuation of the stock is excessive to us, trading at greater than 7 per-cent of assets under management (for context, American comps trade below 2 per cent of AUM). Competition from the incumbent fund managers as well as ETF providers in Canada should only intensify, with a changing regulatory environment in Canada as a result of a new framework called "CRM2" that will require brokers to disclose mutual fund fees in dollar terms. We believe this, too, will weigh on the assets under management of firms who have poor investment performance. Shorted at $27.02 on May 12, 2016
Pair Trade
Long: Secure Energy Services (SES.TO)
Short: Precision Drilling (PD.TO)
This is the sort of pair trade that makes sense to us in a very uncertain commodity price environment. The services that Secure Energy provide to the oil industry are largely environmentally-focused, and with a Liberal government in Ottawa and an NDP government in Edmonton, environmental liabilities have become a hot topic and are actually increasing in importance to the industry. Secure has a low debt load (below 2x 2016 EBITDA), high-quality management and solid baseline EBITDA in a very tough energy market. It is the highest-quality energy service company we have been able to identify and as a result, is the only one we own.
Precision Drilling are contract drillers, and they operate in a business that has been largely commoditized and has changed dramatically since the rig count highs of 2014. Productivity gains and interviews we have done with exploration and production companies would indicate that one rig is required for every two that would have been required two years ago. While this is a marvel of innovation and technological advancement in the oil and gas business, it does not stand to benefit those who actually own the rigs, as far fewer will be required going forward to accomplish the same levels of production (should production in North America ever ramp back up). This essentially means that at the moment there are 1,000 unused rigs sitting in fields across North America. Spot rig rates are still trending lower, and with net debt of nearly $1.6-billion (6.5x our EBITDA estimate), a lack of pricing power is troubling. SES: bought at $8.08 on May 4, 2016. PD: shorted at $7.19 on June 9, 2016
Market outlook:
We are in a worrisome spot where investors seem to believe that central banks and monetary policy are the answers to all of the world's ills, and as a result, investing in equities has now become an exercise in handicapping central bankers. This is an incredibly difficult thing to do, and it has forced many investors to take their eye off the fundamental ball.
After a very long bull market, none of weak earnings growth, unprecedented debt issues around the world, negative interest rates and now what we believe could be the beginning of the end of the EU have been able to take stocks materially lower. We believe that while there are always high quality companies that can be owned for the long term over multiple business cycles, the current margin for error in investing in equities is very low, given the combination of the aforementioned risks and historically expensive valuations. As a result, we believe a properly hedged portfolio is a must.