Stephen Takacsy on BNN-Bloomberg’s Market Call – Oct 31, 2019

Stephen Takacsy on BNN-Bloomberg’s Market Call – Oct 31, 2019

MARKET OUTLOOK

After rebounding strongly in 2019 as fears of an impending recession faded and central banks cut interest rates, equity markets are now choppier as the U.S.-China trade war drags out and corporations start feeling the impact. Large-caps have become extremely expensive as a result of passive ETF investing to the detriment of small- and mid-cap stocks, which have gotten even cheaper. Michael Burry of The Big Short fame recently called this phenomenon the index bubble or ETF vortex and he is investing heavily in small-cap value stocks worldwide. We also see many good long-term opportunities in the neglected and mispriced Canadian small- and mid-cap sector, at valuations well below private market values. IPOs such as Uber priced at ridiculously high valuations signaled a market top for money-losing tech stocks, which are now starting to deflate with WeWork’s failed IPO and its valuation now a fraction of the last private equity round.

Top Picks

Diamond Estates Wines (DWS:CV)

Diamond is the only publicly traded wine company in Canada besides Andrew Peller and the third-largest producer in Ontario. The stock is down this year because of lower export sales to China and loss of two customers at their agency business a year ago, but this is old news. The company is now growing again in all three segments: exports, agency and Ontario retail sales, where Diamond has the largest market share of Vintners Quality Alliance (VQA) wines. The company is benefitting from deregulation in Ontario, where hundreds of grocery stores have started selling wine.

The big news is that Diamond recently announced in July that Lassonde Industries (one of North America’s largest juice companies) has acquired a 20-per-cent stake in the company. This is a game changer. Lassonde has a huge national salesforce which should increase Diamond’s sales to grocery stores across Canada and as well as its agency sales in Quebec. Lassonde also has strong manufacturing and packaging expertise. In addition to improving results over the next few quarters, we also expect Lassonde to acquire the entire company at a large premium to the current share price within the next few years. We recently bought another 4 million shares at $0.19 and increased our ownership to 9.4 per cent of the company.

Tecsys (TCS:CT)

Tecsys is a Montreal-based supply chain management software solutions provider specializing in complex distribution to hospitals, mainly in the U.S., and other high-volume businesses (procurement, warehousing, transportation, sales and distribution and accounting). Tecsys also made two recent acquisitions to expand their reach into Europe (Denmark’s PCSYS) and e-commerce (Toronto’s OrderDynamics).The company is in the process of transitioning from a perpetual license to a software-as-service model, which temporarily depresses reported revenue. We bought the stock recently at an attractive valuation as it pulled back on this perceived slowdown in growth. Meanwhile, the company recently reported a record backlog and rising high-margin recurring revenue which the market will reward with a higher multiple in the future. 2020 should see strong growth in revenue to over $100 million and EBITDA. Tecsys only trades at two-times revenue versus the peer average at four times. 

Baylon Technologies (BYL:CT)

Baylin is a leader in wireless antenna design for mobile, network and infrastructure applications (wi-fi coverage, wireless network densification using small cell systems, and antennas needed for 5G networks). The stock has been demolished since it issued an earnings warning a few weeks ago due to lower capex by U.S. carriers, but it also announced the largest contract in its history with one of the world-leading telecom equipment suppliers for 5G antennas (likely Samsung, Nokia or Erickson). The overreaction is an example of the market’s “shortermism” with stocks these days. Baylin will benefit from huge infrastructure spending over the next 25 years. It’s expected to see a significant increase in sales in 2020 revenues expected to reach $170 million and EBITDA of $20 million. At $2 per share, Baylin is only trading at an enterprise value of six times 2020 EBITDA. Our target price is $4 to $5 within 12 to 24 months based on nine to 10 times 2021 EBITDA similar to peer group.

Stephen  Takacsy, CEO and chief investment officer,

Lester Asset Management

James Telfser on BNN-Bloomberg’s Market Call – Oct 15, 2019

James Telfser on BNN-Bloomberg’s Market Call – Oct 15, 2019

MARKET OUTLOOK

Over the past three months North American equity markets have been marred by an increasing level of volatility. Weak economic data continues to persist with PMI coming in at 47.8 in September, the lowest reading since June 2009. Similarly, non-manufacturing PMI also disappointed with a well below expectations in September. There seems to be no near-term solution to trade tensions, which aren’t helping sentiment. While there are some underlying positive trends in housing and consumer confidence, we worry about the negative drag from the above data points and how global markets will react, especially as Q3 earnings season unfolds.

We’re positioning our client portfolios and underlying strategies defensively with above average levels of cash. Given how accommodating central banks have become, we’re opting to hold more cash and treasuries versus outright puts or shorting the market. We feel comfortable with our positioning in this environment despite markets inching towards new highs in the short term. If you are committing new capital to the market for the long term, like we are with our recently launched U.S. dividend growth fund, the Aventine Dividend Fund, we would recommend picking away at the large liquid names that have been overly punished in recent months. We have also taken notice of several non-resource Canadian small-cap names that have been driven lower for the sake of liquidity.

Our allocations to utilities and REITs have performed well in this environment and while some tactical trading has caused us to reduce this exposure in recent weeks, we still recommend a healthy allocation here. In addition, we continue to favour alternative asset classes, such as private credit and merger-arbitrage strategies which have been consistent performers through the cycle. Lastly, we have also added non-traditional instruments to the portfolio, such as mandatory convertible preferred shares, which have valuation floors in the case of further equity market deterioration.

Top Picks

Akumin (AKU/U:CT)

Akumin has been executing well on their business plan of acquiring and operating diagnostic imaging clinics focusing on MRI, CT scans and other procedures in the U.S. They’re now the number two player in the U.S. outside of publicly traded RadNet (RDNT-US) with 130 centres. Their business has several tailwinds including demographics, operating leverage as they scale and volume growth from insurance companies encouraging patients to utilize freestanding clinics versus the more expensive hospital centres. While growth has been robust, we’re even more impressed with the margin profile at less than 20 per cent on EBTIDA and their ability to integrate new acquisitions. Given their execution to date we believe that the current multiple of five times EV/EBITDA is too far out of line with peers other consolidators. We consider this level to be an excellent entry point as the next phase of their business plan unfolds which should include even more organic growth and free cash flow.

GDI Facilities (GDI:CT)

GDI is one of those great businesses that offers stability (recurring revenue), organic growth and significant catalyst potential. GDI provides services such as cleaning, food sanitation, hotel services, disaster recovery, technical and event support services and maintenance for offices, hospitals, institutional buildings, laboratories, shopping centers and airports. There are several elements to like here including a recent inflection higher in organic growth, a very aligned management team with directors and officers owning 50 per cent of the shares outstanding and a free cash flow profile that provides flexibility. We also believe there will be further consolidation in the industry which provides a significant opportunity for the shares to outperform. GDI has completed over 20 acquisitions since 2005. Taken together, we conservatively model a 15 per cent IRR over the next few years given management’s targets and multiple expansion as this relatively underfollowed story attracts more attention.

Emera (EMA:CT)

Emera offers a compelling combination of growth and defence. The team here has executed exceptionally well over the years and clearly demonstrated that they’re good stewards of our investor’s capital. We would expect gains here to come from a combination of valuation expansion, dividend growth and organic growth. Interest rates globally remain depressed which bodes well for the valuation of utilities and other interest sensitive sectors. Emera is trading at 18 times expected earnings and has a dividend yield of 4.7 per cent. This comes with 95 per cent of their asset base being regulated or very predictable.

James Telfser,

Aventine Asset Management

Brookfield Infrastructure Partners L.P….Recap of Investor Day

Brookfield Infrastructure Partners L.P….Recap of Investor Day

BIPC Should Support Higher Valuation for Unique Portfolio

Event

Late last week, BIP hosted a well-attended Investor Day in New York.

Impact: POSITIVE

 ■ We believe that BIP has good visibility to another year of above-average growth in 2020. The LP expects same-store growth in constant currency to be at the high-end of its 6%-9% target range, with same-store growth to be supplemented by the commissioning of a healthy capital project backlog and by the net benefit of BIP's recent capital recycling and M&A activity. In particular, the LP expects to generate $1bln of net proceeds on the sale of four mature businesses, with the proceeds to be redeployed into four new investments with an average going-in FFO yield of ~12%. Our sense is that BIP's remaining deal pipeline is robust, with a focus on data infrastructure and energy infrastructure in North America and Europe.

■ BIP announced its intention to launch Brookfield Infrastructure Corporation (BIPC) in H1/20 by way of a tax-free distribution to unitholders, whereby unitholders will receive one share of BIPC for every nine units of BIP. The BIPC shares will be structured to provide the same economics as BIP through a traditional corporate structure. The creation of BIPC should expand BIP's potential investor base to include investors who would not otherwise invest in LPs due to tax considerations or other reasons, and should position BIP to qualify for broader index inclusion. All else being equal, we expect BIPC to support a higher valuation for BIP's unique portfolio over time.

TD Investment Conclusion

■ Our target price increased to $53.00 from $49.00, as the impact of a modest increase in our weighted average valuation multiple and a roll-forward in our target price horizon by one quarter more than offset slight downward revisions to our near-term forecast to reflect weakness in the BRL and the potential for some modest slippage in the timing of certain deal closings.

■ In our view, BIP provides investors with a unique opportunity to own a welldiversified portfolio of long-life infrastructure assets that enjoy high barriers to entry, generate stable cash flows, and require relatively minimal maintenance capital expenditures. We believe that the units offer an attractive combination of yield and growth.

Details

Stable Base Cash Flow 

BIP generates very resilient cash flow, with ~95% of its cash flow either regulated or contractual. The average contract duration is nine years, and ~85% of the LP’s contracted volumes are with investment-grade counterparties. 

BIP’s recent capital recycling and M&A activity have meaningfully improved the diversification of its portfolio by geography and by sector.

The majority of BIP’s cash flow is not GDP-sensitive (~60%), and most of the GDP-sensitive cash flow is in the transport sector. The Brazilian toll roads comprise ~70% of the transport FFO that is volume-sensitive, and one could argue that those cash flows should have limited downside vs. the current run-rate given that the country is in the midst of a slow recovery from a severe recession.

Good Visibility to Strong Double-Digit Growth in 2020 

BIP expects same-store growth in constant currency to be at the high-end of its 6%-9% target range in 2020, with same-store growth to be supplemented by the commissioning of capital projects and the net benefit of the LP’s recent capital recycling and M&A activity. 

The capital project backlog was $2.2bln as of Q2/19, which represents ~13% of the existing asset base (proportionate basis), and should be commissioned over the next 12-36 months. 

BIP expects to generate net proceeds of $1bln on the sale of four mature businesses, with the proceeds to be redeployed into four new investments with an average going-in FFO yield of ~12%, and higher long-term growth potential vs. the assets sold.

Overview of Recent Transactions

New Zealand Data Distribution Business (Vodafone NZ)

High-quality data distribution business Nationwide wireless and fiber network Serves ~2.5mm customers…

Enterprise Value = 2.3 Bil…BIP’s Equity Investment = 200 Mil

North American Rail Business (Genesee & Wyoming Inc.)

Largest short-haul rail operator in North America ~26,000 km of track Diversified across commodity groups with 3,000+ customers…

Enterprise Value = 8.4 Bil…BIP’s Equity Investment = 500 Mil

North American Regulated Gas Pipeline

Co-controlling interest in two operational natural gas pipelines 740 km of newly-constructed assets No volume or commodity price risk Fully-contracted under long-term, take-or-pay arrangement U.S. dollar contracts and shippers…

Enterprise Value = 3.2 Bil…BIP’s Equity Investment = 150 Mil

Indian Telecom Towers (Portfolio Acquired from Reliance Industries)

Bilateral arrangement for corporate carve-out ~130,000 communication towers 30-year Master Services Agreement with anchor customer…

Enterprise Value = 7.9 Bil…BIP’s Equity Investment = 400 Mil

BIPC Launch

BIP announced its intention to launch Brookfield Infrastructure Corporation (BIPC), a publicly-listed Canadian corporation in H1/20. 

BIP will distribute BIPC shares to unitholders on a tax-free basis, whereby unitholders will receive one share of BIPC for every nine units of BIP, giving BIPC an initial market cap of ~$2bln. 

The transaction will be analogous to a stock split from an economic/accounting perspective, and the BIPC shares will be structured to provide the same economics as BIP units. The dividends/distributions will be equivalent, and BIPC shares will be exchangeable into BIP units at any time at the shareholder’s option. 

The objective of establishing BIPC is to: 1) expand BIP's investor base by attracting new investors who would not otherwise invest in LPs due to tax considerations or other reasons; and 2) position BIP to qualify for broader index inclusion (Russell indices, MSCI indices, etc.) 

All else being equal, we expect the launch of BIPC to support a higher valuation for BIP’s unique portfolio over time.

Strong Investor Appetite for Infrastructure Debt

BIP highlighted that the search for yield has led to an ample supply of debt at historically low cost, with a noticeable increase in non-investment grade lending. 

Despite bull market conditions, the LP is maintaining a disciplined and conservative approach to financing the business, with a focus on securing covenant-light financing on attractive terms, with a leverage profile that ensures ongoing access to a variety of financing sources.

Valuation

The distribution yield is 4.1%, which is below the historical average of 4.8% (2011- present), but reflects a normal spread vs. the U.S. 10-year bond yield.

Justification of Target Price

We find it difficult to identify a single company or group of companies that is truly comparable with BIP; therefore, we value the units with reference to a wide range of peer companies that own infrastructure assets.

The net asset value estimate supporting our target price corresponds to a weighted average EV/EBITDA multiple of ~14.1x, which is applied to our earnings forecast for the 12 months ending September 30, 2021. We believe that the modest increase in our weighted average valuation multiple to ~14.1x from ~13.7x is supported by our view that the launch of BIPC, which broadens BIP’s investor appeal and potential for index inclusion, should support a higher valuation for the LP’s unique portfolio over time.

Key Risks to Target Price

Key risks to our target price include: 1) higher-than-expected bond yields; 2) significant FX/commodity price movement; 3) general economic conditions; 4) control by the General Partner; 5) acquisitions that do not create unitholder value; 6) operational disruptions; and 7) sovereign risk.

Resources,

Cherilyn Radbourne, CA, CFA,

TD Securities Inc.

https://marketsandresearch.td.com/tdwca/Reports/Report?documentKey=2437-20190930_MR_4-ActionNote