Stephen Takacsy, president, CEO and CIO, Lester Asset Management
FOCUS: Canadian stocks
Top Picks: Quarterhill, Pollard, AG Growth
MARKET OUTLOOK:
We continue to see a very positive environment for both stocks and bonds. We’ve been saying for a couple of years now that inflation was “transitory” and would naturally decline to nearly two per cent as supply chains unclog and demand normalizes. It just took a little more time as companies kept passing on price increases. We also believe that the aggressive rate hikes actually contributed to inflation through rising shelter costs, for example, exasperated by immigration combined with a housing shortage. This is why central banks pivoted last fall.
The North American economy has been resilient despite higher rates, with employment remaining strong and savings rates still high. However, the North American job market and economy are weakening, and year-over-year inflation has reached the two per cent target in Canada and is close in the U.S. This is why the U.S. Federal Reserve and the Bank of Canada are cutting rates faster now. We’ve also always believed in a soft landing, and even mentioned last time that we may be entering a “Goldilocks” scenario where disinflation or even deflation (which we had in Canada in August) occurs alongside a still growing economy. However, if the economy weakens too much, this can still be seen as “good news” because rate cuts will be faster and deeper. However, one will need to be selective in what sectors and companies to invest in as the consumer is slowing down.
As we predicted, the Canadian fixed income market has rallied strongly over the past year (we are up over 14 per cent in our CAD Fixed Income Fund in the last 12 months) yet still offers very attractive returns in corporate bonds and preferred shares which still trade at inflation-beating yields in the six- to seven-per cent range representing equity-like returns with very low risk. In Canadian equity, small/mid-cap stocks still offer compelling value and have rarely been so cheap having been decimated over the past few years by institutional flows out of Canada and mutual fund redemptions. Private equity firms and strategic buyers have taken notice and have been snapping up Canadian companies at huge premiums, including a few in our portfolio this year like Logistec, MDF Commerce, and Park Lawn. Other pockets of value include large-cap dividend stocks in sectors such as telecom (Telus yielding 6.8 per cent), energy infrastructure (Enbridge yielding 6.6 per cent) and banks (BMO yielding 5.1 per cent), utilities and real estate investment trusts (REITS) having already rallied strongly.
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TOP PICKS:
QUARTERHILL (QTRH TSX):
Quarterhill is one of the world’s leading ITS providers. It is a leader in electronic tolling for highways in the U.S. and a global leader in traffic enforcement, data collection, and weight-in-motion technology. It has a backlog of $500 million and a large pipeline of potential projects as governments are looking to install more technology on roads to collect more revenues from drivers to help pay for transportation infrastructure. Also, QTRH is gradually becoming a technology company and has developed AI tools to monetize the huge amount of data it collects to enhance road safety, traffic management, and vehicle tracking.
It has also strengthened its board of directors and new management who have been buying a lot of stock over the past year. The shares have been weak recently due to some low-margin projects that are still in the implementation phase, but results are expected to significantly improve over the next few quarters as higher-margin recurring revenue kicks in. We expect the shares to go back over $2 by year-end, with an eventual take-out in the $3 to $4 within a couple of years as the industry consolidates.
POLLARD BANKNOTE (PBL TSX):
Pollard is the second-largest supplier of instant printed lottery tickets in the world and a leader in electronic lotteries (iLottery). There are only three players who print instant tickets for governments in North America and Europe, so huge barriers to entry. The instant ticket market continues to grow as governments need revenues from lotteries. Pollard’s shares were staging a strong comeback this year as inflation subsided on input costs such as paper, ink and foil which could not be passed on to government lotteries as contract prices were fixed. However, most of its contracts have now been renewed at much higher prices, and so the company expects strong sales growth combined with a strong margin improvement which should lead to record profits this year. The stock pulled back recently on news that they lost the renewal of an iLottery contract to its JV partner Neo Games. However, Pollard has an even newer technology to win iLottery contracts on its own and recently won the state of Kansas, so the stock jumped back up from its lows. We had trimmed our position in the $30s and are now buying back in the mid $20s. Note that Brookfield Business Partners paid US$6 billion or nearly 14 times EBITDA for Scientific Games’ instant lottery business a few years ago, which would value Pollard at over $40 per share. The stock is currently a bargain trading at under seven times EBITDA.
AG GROWTH (AFN TSX):
AG Growth is a leading global manufacturer of handling and storage systems for grain, fertilizer, and other commodities for the agriculture industry. The company is projecting another record year in 2024 with EBITDA of $300 million plus. It has a record backlog and strong demand from international commercial markets such as Brazil, India and Eastern Europe as these regions are investing heavily to upgrade its farming infrastructure. This is a great way to play the global agriculture sector without taking on commodity risk. The company is also generating significant free cash flow and is deleveraging quickly which is another tailwind for the stock price which is currently trading at a bargain of less than seven times forward EBITDA. The stock has rallied a few times on news that the company had received a takeover offer in the $60s. We estimate that AG Growth is worth over $85 per share and expect the company to be sold as it is widely held and currently vulnerable to a take-over offer.
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| QTRH TSX | Y | Y | Y |
| PBL TSX | Y | Y | Y |
| AFN TSX | Y | Y | Y |
Past Picks: SEPTEMBER 25, 2023
SAVARIA (SIS TSX)
- Then: $14.18
- Now: $20.94
- Return:48%
- Total Return: 52%
MDF COMMERCE (MDF TSX)
- Then: $3.56
- Now: $5.80
- Return:63%
- Total Return: 63%
VELAN (VLN TSX)
- Then: $11.20
- Now: $7.00
- Return:-37%
- Total Return: -37%
Total Return Average: 26%
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| SIS | Y | Y | Y |
| MDF TSX | N | N | N |
| VLN TSX | Y | Y | Y |
