Stephen Takacsy's Top Picks: January 22, 2024
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Stephen Takacsy, president, CEO and CIO of Lester Asset Management
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Market outlook:
We see a positive environment for stocks and bonds for 2024. We have always believed that inflation was “transitory,” caused by supply and demand imbalances and supply chain disruptions post-pandemic, and a spike in commodity prices fuelled by Russia’s war on Ukraine. The rapid rise in interest rates by central banks actually contributed to inflation through rising shelter costs. Inflation is declining naturally as these anomalies normalize, not because of the rate hikes. This is why Powell and Macklem pivoted. It was only a question of time before bonds would rally on lower inflation data, and stocks would follow suit, as witnessed in November and December. The North American economy has been resilient despite higher rates and if it does slow down too much, the equities and bond markets will see “bad news” as “good news,” although one will need to be selective. Since the job market remains strong and savings rates are still high, we might even get a “goldilocks” scenario where disinflation or even deflation occurs along with a growing economy.
In fixed income, we continue to buy high-yielding short-term securities such as corporate bonds, hybrid debt, and rate-reset preferred shares, which still trade near historically high yields in the six-eight per cent range representing equity-like returns with low risk. In Canadian equity, we are adding to our small and mid-cap stocks, which haven’t been this cheap since the great financial crisis, having been decimated over the past few years by institutional flows out of Canada and retail fund redemptions. Private equity firms have taken notice and have been acquiring Canadian companies at big premiums. Other bargains abound in higher yielding dividend sectors such as telecom and energy infrastructure, as well as stocks like Boralex in the renewal energy sector, which have very strong organic growth tailwinds.
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Top picks:
Tecsys is a Montreal-based company that develops and sells supply chain management software solutions, mainly to healthcare networks in the U.S., such as hospitals and clinics, as well as complex distribution businesses like auto parts and big omnichannel retailers. Their solutions are end-to-end from purchase order management and fulfillment to inventory and warehousing, to accounting and analytics. We recommended Tecsys at $15 back in 2019 and it was one of the 30 best performing stocks on the TSX over the next three years, reaching more than $60. However, it sold off during the correction in 2022 and is only now starting to recover, despite the company doubling its revenues in the past four years. More than 60 per cent of its revenues are now high-margin recurring software. Tecsys is profitable and has been investing in organic growth, however it is starting to focus on margin expansion as selling, general and administrative expenses (SG&A) costs come down. Tecsys trades at under 2.5 times revenues, a significant discount to its peer group, so is a great buying opportunity now. Ultimately, Tecsys could be worth as much as $100 if sold to a strategic buyer.
Park Lawn owns funeral homes, crematoria, and cemeteries in Canada and the U.S. It’s a recession-proof high-margin high-barriers-to-entry business with strong tailwinds from aging demographics. Strong management team based in the U.S., where they are focused on a mergers and acquisition strategy to consolidate a still very fragmented industry. The stock was more than $40 in 2022 when sales surged from higher death rates during the pandemic. The massive pullback to less than $20 is due to several factors: tough prior year comps, a flight out of small-cap stocks, leverage, and deletion from the TSX Composite Index. This has created a great entry point as PLC’s valuation is now at an all-time low of less than eight times forward Earnings before interest, taxes, depreciation, and amortization (EBITDA). The company is now buying back shares and company recently divested of some low margin assets at a very good price and significantly improved its balance sheet, so results this year should show a significant margin and free cash flow improvement. We bought more shares less than $20.
QBR is the dominant cable provider in Quebec, and now the fourth-largest wireless provider in Canada. It has benefitted tremendously from Rogers acquiring Shaw and having to divest the Freedom mobile assets to QBR on very attractive terms. QBR also bought spectrum on the cheap and is benefitting from a favourable regulatory regime. This is allowing QBR to expand into Ontario and Western Canada with low capex. As a result of strong and growing free cash flow, leverage is expected to come down to less than three times this year and an upgrade by S&P to an investment grade credit rating on its debt should be a big catalyst for its bonds and also its stock price. The company has the highest ROE and best growth potential in the wireless industry, yet trades at the cheapest valuation with an EV/EBITDA multiple less than seven times versus more than eight times for Rogers, BCE and Telus. We expect overall wireless competition in Canada to remain disciplined, which will also benefit BCE and Telus whose shares are trading at attractive dividend yields of 6.9 per cent and 6.1 per cent respectively.
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Past picks: January 31, 2023
RICHELIEU HARDWARE (RCH – TSX):
Are tied to home renos and there was huge pent-up demand coming out Covid. So, RCH stocked up on inventory and gained market share. Was up 30% last year, but last week they reported lower margins that will persist given excess inventory (that will last a few quarters). So, he took some profits around $45, but will buy them back. A strong balance sheet and track record.
Then: $39.57
Now: $43.09
Return: 9 per cent
Total Return: 10 per cent
PET VALU (PET – TSX):
Is the leading pet retailer in Canada as pet adoption continues to grow. This business is recession-proof. The valuation had to come in. Organic same-store sales growth has slowed a little, but management has delivered by expanding store count in underserved markets. The PE has fallen from 30
Then: $39.79
Now: $30.45
Return: -23 per cent
Total Return: -22 per cent
FLAGSHIP COMMUNITIES (MHC.U – TSX)
A pure-play manufactured home communities company with over 60 in the US midwest. Most of their residents own their own homes mortgage-free, so the base is solid. Low capex. A fragmented industry. Free cash flow is growing through rising rents and strong demand. They grow their dividend. The stock has performed well against REITs.
Then: $15.99
Now: $15.59
Return: -2 per cent
Total Return: 0.7 per cent
Total Return Average: -4 per cent
