ACE Fund: August 2016 Manager Letter

August 31, 2016



31 August 2016

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Aventine Canadian Equity Fund

Monthly Fund Manager Update – August 2016

Executive Summary

The ACE Fund gained 0.3% in August, in line with the total return of the broad Canadian market. We saw excellent performance from a number of our core positions, however this was offset by the underperformance of two companies in particular which we highlight below.

Fund Documents

Purchase Documents


Media Appearances

Performance Overview

Current Performance

1 Month 6 Months Year to Date
Aventine Canadian Equity – Class F +0.3% +8.6% +2.5%


Historical Performance

1 Year 3 Years* Inception*
Aventine Canadian Equity – Class F +10.9% n/a +8.9%
* Performance for periods >1 year are annualized.

Top Holdings

Linamar Corp. (LNR-T) 5.9%
goeasy Ltd. (GSY-T) 5.8%
Clearwater Seafood Inc. (CLR-T) 5.2%
Winpak Ltd. (WPK-T) 5.1%
New Flyer Industries Inc. (NFI-T) 5.0%

Metrics of Average Company

Market Capitalization ($B) $2.5B
Expected EPS Growth 34%
Forward Price-to-Earnings 13.4x
Dividend Yield 3.1%
Return on Equity 12.3%

Fund Commentary

We entered August riding a hot streak of positive company updates that had seen the Fund post strong performance in July, rising 4.8%.  Quarterly financial reporting for the majority of our holdings was concentrated across a few weeks in late July and early August, and based on the early results we had good reason for continued optimism.  The read through from our management teams was encouraging and when forward guidance was given, it generally exceeded our expectations. In short, portfolio companies from a wide array of different industries were growing cash flows at superior rates while trading at a comfortable discount to comparable assets and our estimate of their value.  This should be taken as a very constructive sign for Canadian Equities in general.

However, not all the news in August was good and two companies in particular left us disappointed.  The negative performance impact from these two companies offset what would have otherwise been a very positive and productive month. We have since exited both positions.

Overall, the monthly result for ACE in August was a gain of 0.3%.  This was essentially in line with the total return of the broad Canadian market, although with a much different underlying performance attribution. Despite similar results in August, investors should keep in mind that our portfolio has a materially different sector composition than the broad market (an “active share” of 95%), while trading at significantly more attractive valuation and internal return metrics.

Portfolio Updates

The Good

On the positive side of the ledger we had excellent updates from core positions Goeasy (GSY-TO), ZCL Composites (ZCL-TO) and Premium Brands (PBH-TO).  All three businesses faced recent scrutiny as several analysts publicly voiced doubts that these companies could continue to grow cash flows at an accelerating pace, as they have over the past couple of years. Each delivered solid second quarter results and reported progress on various growth initiatives, whether that growth was expected to be a product of acquisition, diversification or even a narrowing in business focus. Some highlights follow below:

  • As an “alternative” lender, Goeasy’s (GSY-TO) easyfinancial division continues to face a chorus of questions regarding its ability to contain credit losses in the face of ongoing employment challenges in certain markets such as Alberta.  Yet management continues to drive this business exceptionally well and grow in a controlled, methodical manner, as evidenced by improvements across all aspects of their loan book. Goeasy’s share price increased 14.9% in August.
  • Despite posting a second quarter result which somewhat fell short of analysts’ estimates, ZCL Composites (ZCL-TO) announced in August that they would be winding down their “non-strategic” above-ground storage tanks business. This business line has been a significant cash drain on ZCL for several years and its shuttering was anticipated after an activist investor, with whom we are familiar, joined the board earlier this Spring.  ZCL’s share price increased 11.1% in August.
  • Premium Brands (PBH-TO) posted an in line second quarter relative to expectations, however executives made several comments on the conference call regarding potential acquisition activity. Shortly after the report PBH announced the purchase of Fletcher’s Fine Foods’ US operations, which helped propel the stock up 10.5% in August.

As value investors, our most meaningful gains are realized from situations where our early, contrarian thesis on a stock begins to emerge as the new consensus view over time. The risk/reward trade off becomes very skewed to our benefit if we can accurately assess that a currently “out-of-favour” company will successfully execute on its efforts to stabilize or grow their business such that the market is positioned wrongly. A change in the broad sentiment towards a company from negative to positive provides a very powerful expansion in the valuation multiple.  As a result, we look very closely for signs of material positive changes in a company’s business strategy, market share, pricing power or cost structure. It’s important to note that this assessment goes both ways and when companies post results or provide updates that substantially miss our internal estimates, we have no choice but to discount the reliability of our outlook.  Cash flow predictability is a key investment criteria for us and if management demonstrates, in our opinion, an inability to accurately forecast their own businesses or manage market expectations well, then we cannot continue to hold it as a major position in the Fund.

The Bad

Unfortunately, we had two such companies last month and the cost of these disappointments had a negative impact on the Fund.  The first, from Concordia Healthcare (CXR-TO), was particularly frustrating as we had been relatively vocal backers of management and what we saw as the unfolding of a global growth story.  In their most recent commentary, CXR spoke for the first time to increased competition and the loss of market share in core product lines. These losses were far more severe than formerly guided to us. Several other ongoing issues at the company had already caused us to significantly reduce our stake, but this clear impairment of CXR’s business model was the final straw for us. Since we closed our position at a loss in mid-August, the company’s stock has fallen an additional 40%.

We like to align ourselves with businesses where insiders are significant owners, and Airboss definitely fits this bill with Gren Schoch, the company’s founder and Chairman, owning 20% of the company.  We’ve been impressed over the years by Mr. Schoch’s ability to pilot the company through cyclicality in major business lines such as mining and defence, but it seems that the past few quarters have been particularly difficult and management has delivered some nasty negative surprises. Predictability offers companies a higher valuation multiple, but as you can see below, Airboss has done a poor job guiding the street which has cost it support from institutional investors.  While we still believe that the company has some exciting opportunities ahead, management needs to do a better job in communicating with shareholders. Despite a cheap valuation, we are back on the sidelines with Airboss until we see the needed performance improvements in their core business and related disclosures. While alignment of interest is important, it can turn negative if a controlling position becomes less considerate to the needs of their minority partners.

Maintaining a Sell DisciplineThe key to a good investment process is to be unemotional about your sell decisions and we often tell individual investors who are holding losing positions to cut them loose in favour of better ideas. It’s more than just an emotional and financial pain of loss that investors experience, there is also an opportunity cost involved in foregoing potential gains elsewhere. Knowing when to sell is a very tough decision, but in the case of Airboss and Concordia above, our portfolio management activities were such that our capital at risk declined as our evaluation of the upside potential deteriorated. When the time came to ultimately exit, our positions were a fraction of their maximum allocation and we executed on the sell without letting emotion get in the way.  As is often the case, we have a stable of new ideas and have been adding some great assets to the portfolio from a diversity of industries such as specialty automotive, delivery services and building materials.

Market Outlook

We continue to see intermediate term upside in this market and have not been shy about allocating capital towards new names.  Our risk model continues to provide a low-stress reading on broad financial conditions and we are only a few percent away from the major stock markets indices breaking into new higher trading ranges.  The last two months can best be characterized as a “choppy” sideways period for the markets as the early stages of an underlying leadership rotation have been developing.  We still believe that cyclicals will take the markets to the next level which is where we have been concentrating the Fund’s investments.  While economic data in recent weeks has been coming in weaker (a deterioration from very strong data in June and July), third quarter real GDP remains robust, currently tracking above 3%.  This is a positive sign for corporate earnings and we continue to expect the near two-year old “earnings recession” to come to an end in the near term.

Aventine Update

We would like to announce the addition of a new Associate to the Aventine team, Shannon Veitch, who joins us in a Client Support and Service role. Shannon will be responsible for providing effective communication on the firm’s investment strategies while also responding to incoming client inquiries. Shannon is also responsible for Aventine’s client marketing initiatives and social media activity, which we are trying to build more of each week.

Prior to joining Aventine, Shannon worked for SunLife Financial where she met with many high net worth individuals and families that were interested in learning more about succession planning and insurance solutions which could benefit them. She holds a degree in Advanced Accounting and a Bachelor of Commerce from the University of Guelph. She recently completed the Canadian Securities Course and is now planning to obtain her CFA designation over the next few years.  We are thrilled to have her as part of the team and look forward to introducing her to many of you in the coming months.

We hope you all enjoyed the beautiful Summer weather this year and we wish you all the best for the Fall.

Performance Presentation

Fund Inception: March 31, 2014

This email communication is intended to provide you with information about the Aventine Canadian Equity Fund managed by Aventine Management Group Inc. This Fund is distributed by prospectus exemption in various jurisdictions across Canada, please contact Aventine Management Group Inc to discuss if you may be eligible to invest.  Important information about the Fund is contained in its Offering Memorandum which should be read carefully before investing and may be obtained from Aventine Management Group upon request, or by clicking on the link at the top of this email. The Offering Memorandum of the Aventine Canadian Equity (“ACE”) Fund does not constitute an offer or solicitation to anyone in any jurisdiction in which such an offer or solicitation is not authorized, or to any person to whom it is unlawful to make such an offer or solicitation. All investors should fully understand their risk tolerances and the suitability of this Fund prior to making any investment. Rates of return presented for all periods greater than one year are the historical annualized compound total returns for the period indicated. For periods less than one year the rates of returns are a simple period total return. Rates of return do not take into account income taxes payable that would have reduced net returns. The performance presented for the ACE Fund is the performance of the target series of F Class units. The value of the Fund is not guaranteed and will change frequently. Past performance may not be repeated. All credited third party information contained herein has been obtained from sources believed to be reliable at the time of writing but Aventine Management Group Inc makes no representations as to its accuracy. 
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