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Jerome Hass is portfolio manager, Lightwater Partners. His focus is Canadian mid caps and long-short strategies.

Top Picks:

DirectCash Payments (DCI-TSX)

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DirectCash Payments Inc. operates more than 21,000 ATMs worldwide. It is the largest ATM provider in Canada and Australia, and the third-largest provider in Britain. DirectCash earns a small fee on each ATM transaction that it processes. Direct is an ideal stock for an investor looking for: (i) attractive dividend yield (8 per cent); (ii) sustainable payout ratio (about 52 per cent, recently increased dividend); (iii) low valuation (7x EBITDA 2015); (iv) business model is easy to understand; (v) highly predictable cashflows; and (vi) an 'uncrowded' story with limited sell-side analysts coverage.

Pair Trade:

Allegiant Travel Co. (ALGT-Nasdaq) / *Short* WestJet (WJA-TSX)

The conviction or motivation for a pair trade usually lies on only one side of the trade; in this case, we thought WestJet was a SHORT. The share price of both WestJet and Air Canada had impressive runs as the price of jet fuel tanked along with crude oil prices. WestJet's client base is still heavily focused on Alberta and western Canada. We believed the street was underestimating the impact of the oil price on the western Canadian economy. As well as the effect on the weaker Canadian dollar would make international travel more expensive for Canadians in general. To hedge our short position, we were reluctant to use Air Canada, as it would be similarly affected by the weaker Canadian dollar, whereas a U.S. airline would not face this issue. Allegiant ($2.9-billion market cap.) is an ultra-low-cost airline and travel company focused primarily on tertiary destinations in the USA, usually without much competition on its routes. Allegiant also has an old inefficient aircraft fleet, so it is one of the biggest beneficiaries of cheaper jet fuel prices.

NXT Energy Solutions (SFD-TSX Venture)

Not many oil & gas related stocks are trading near their 5-year high but there are a number of reasons why NXT is one of them. Firstly, oil & gas companies are desperately trying to reduce costs after a 50 per cent drop in crude prices and NXT's technology is 1/30th the cost of typical 3D & 2D seismic programs. Their technology helps oil & gas companies pinpoint their exploration efforts; it is not a substitute for traditional 3D & 2D seismic but instead it focuses their targets much more accurately. National oil & gas companies – which are revenue-maximizing, not profit-maximizing entities – want to increase production due to the fall in crude prices, in order to boost revenues to their respective governments. Second, NXT just signed a deal with a new client that is a national oil company. The $13-million deal should be completed by the end of Q3 with estimated gross margins of 80 percent. We believe the company is on the cusp of more of these types of deals in 2015 with Mexico, Pakistan and possibly Bolivia. We like NXT as an investment because it has very high gross margins (80-85 per cent), no debt with approximately $6-million in cash, low overhead and operating costs, and a strong growth outlook. Finally, the company owns a library of data that it intends to monetize in the form of 'verticals'. Without providing any capital of its own, NXT would supply exploration data for an area / region in exchange for a significant equity stake, rights to supply further exploration services, and a royalty income stream from production. None of this potential is yet priced into the stock.

Past Picks: April 16, 2014

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*Short * Veeva Systems (VEEV-NYSE)

New commentary: Our initial short thesis was that:

  • The market is mature with industry sales growth would be limited to single digits.
  • With four large players in the market, Veeva was unlikely to significantly increase market share.
  • The stock was overvalued given its limited growth prospects (still overvalued at 80x PER and 40x EV/EBITDA for 2015 – about twice its peer average).
  • Management and insiders were heavy sellers of the stock (they continue to sell heavily).

We think the short thesis has gotten even stronger:

  • The 800 pound Gorilla has entered the ring; it has taken a few months but Salesforce can undercut Veeva with its product and cost advantage.
  • Q4 results confirmed our thesis; the stock dropped 21 per cent on March 4 when Q4 released.

Then: $22.63; Now: $27.12 -19.84%; Total return: -19.84%

Currency Exchange International (CXI-TSX)

New commentary: CXI is a wholesale provider of foreign currency services to financial institutions such as banks, credit unions, and trust companies.

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  • It’s a low-risk, high-growth business, and I think it has the potential to be something very big
  • The market has only started to awoke to the growth potential ahead of CXI, driving up the stock by about 135 per cent in the last 12 months.
  • FY2014 numbers were fantastic: sales and EBITDA both grew 40 percent YoY.
  • Management is confident that they can grow the business organically at a 30-per-cent rate over the next few years. We believe they will be able to exceed that rate over the next 3 years; 50-per-cent growth is not out of the question.
  • Still not a well-known story; another ‘uncrowded’ trade; only three sell-side Analysts cover the stock.

Then: $12.70; Now: $30.09 +136.93%; Total return: +136.93%

Pair: Long Guardian Capital (GCG.A-TSX) / *Short* Bank of Montreal (BMO-TSX)

We added to both positions. Guardian last purchased on Feb 9, 2015 at $17.03. BMO last purchased at $77.77

Guardian holds about 4.7-million shares of the Bank of Montreal and other investment securities which are worth a total of $16.69 per Guardian share (as of 31 Dec. 2014) vs. a $18.70 current share price (89 per cent of share value). If you strip out the value of its investment portfolio, the underlying business is essentially a free option. If you apply AGF's valuation to Guardian's underlying business, one gets a share price of about $31. Guardian is an attractive take-out target; there are few independent asset managers of its size. One morning we will wake up to read about such a bid; in the interim we hedge our position by shorting BMO common shares against it.

Guardian:

Then: $17.20; Now: $18.57 +7.97%; Total return: +9.64%

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BMO:

Then: $76.08; Now: $79.67 -4.72%; Total return: -8.94%

Total return average: +39.11%

Market outlook:

A pressing issue in the business press these days is what will happen to the price of oil? While thought-provoking from an economic and a political perspective, we do not view speculation on the direction of oil as a key tenet of successful investing. Our success is predicated on being early on misunderstood and underfollowed companies, rather than catching momentum in a commodity play. As a matter of policy, we do not invest directly in resource names. This has had the effect of taking out considerable amount of volatility from the portfolio.

From a macroeconomic perspective, our views and investments are also somewhat unrelated. We do not use leverage; in fact, we hold large cash weightings most of the time. Our volatility is further dampened by our offsetting short book. The combined effect is a portfolio focused on alpha, or stock specific returns. In aggregate, our "bottom-up" approach results in a portfolio with low relative volatility and low correlation to the index, desirable properties over the long run.

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