Highlights of our November letter:
- The selling in commodities continues
- The importance of being different
- An update on ACE Fund core holdings CCL Industries and Linamar
- A new position in Concordia Healthcare
- Market outlook
The selling in commodities continues
Against a backdrop of weaker than expected global growth, many industrial commodity prices continued to slide in November. WTI Oil fell 18% during the month (after a 12% fall in October) and the losses in energy-related assets actually accelerated into month end after OPEC officials decided against officially supporting crude prices through coordinated production cuts. Market participants who bet that this outcome was “priced in” were swiftly treated to a new 5-year low as the benchmark price experienced one of its largest single day declines on record. While there has been much discussion in the media surrounding motivations, alignments and pain thresholds of major players in the oil market, no single factor can be pointed to as a definitive explanation of the recent price action. Of particular interest are the below charts, highlighting the impact that (1) resurgent US production growth is having on OPEC / Saudi Arabia, (2) current market prices are inflicting on Russia, and (3) the decline in value of Canadian energy prices since mid-summer (click the images for larger charts).
Falling oil prices may be making loud headlines, but energy is far from the only sector in the commodity complex that has been hurting Canadian portfolios. Industrial base metals such as copper and iron ore have also sold off sharply and many companies in the S&P/TSX Materials sector are either at or below their trough prices of the great recession. Readers will recall from prior letters that our investment approach favors companies and industries with positive price trends, attractive valuations and earnings catalysts, the lack of which across most of the resource sector this year has kept our interest focused on other sectors. At the end of November our exposure to the energy and materials sectors was roughly 9% on a combined basis. We were also well positioned with a healthy cash reserve of 6%, which has provided us with the flexibility to add to positions in Technology and Industrials at bargain prices in early December.
The importance of being different
It is a frequently overlooked fact in the investment industry that the best way for active managers like ourselves to generate consistently positive returns over time is to own a portfolio that is significantly different from the broad market. This characteristic is specifically beneficial when investing in an equity market like Canada, which is heavily concentrated in financial and resource sectors. For instance, the ability to materially differentiate our portfolio from the S&P/TSX Index has been very helpful over the past few months in our efforts to preserve capital and lower volatility.
Portfolio differentiation is such an important attribute to long term returns that professional consultants have actually created a statistic to measure exactly how different any particular fund is versus its benchmark, called “active share”. The simple definition of active share is the percentage of your portfolio that is different from the benchmark. This statistic provides an excellent and simple scorecard which ensures that we adhere to our investment principles – concentrated, active, sector agnostic. We believe that too many Canadian equity funds are essentially indistinguishable from the broad Canadian market, and would like to highlight that the ACE Fund has an extremely high active share at 92%.
We had a significant number of our companies report in the month of November and we were quite pleased with the results. The most encouraging updates came from Linamar and CCL Industries.
Linamar (LNR-T, +17% in November) has now beaten earnings expectations seven quarters in a row by an average of 20%, with the most recent positive surprise coming in at 30% above the mean earnings estimate. Linamar is benefiting greatly from their Skyjack business, which sells equipment like scissor lifts and telescopic booms, as well as from their expanding scope in auto parts. Linamar boasts an industry leading return on equity at over 22% and management has been guiding earnings higher for next year based on strengthening margins.
CCL Industries (CCLb-T, +6% in November) continues to impress us with their industry leading position in the label making market as well as extremely low earnings and cash flow volatility. In November, they reported a 3% earnings beat on improved margins and outperformance by their Avery division. CCL is an impressive free cash flow generator which will benefit strongly from a lower Canadian Dollar. CCL’s balance sheet continues to strengthen and our expectation is to see management pursue further consolidation in the label industry, solidifying their position as a leading firm within this sector.
New position: Concordia Healthcare
One of the more interesting areas on our radar, and an area in which we have been successful investors over the past few years, is the Healthcare sector. Healthcare comprises only 3.5% of the Canadian market and any headlines on the sector are typically dominated by Valeant Pharmaceuticals. This area has recently created outsized returns for Canadian investors due to many mergers, acquisitions and initial public offerings over the past couple of years (Paladin Labs, Patheon and Atrium Innovations, to name a few). We are excited to announce that we have built a position in Concordia Healthcare (CXR-T, +14%), an exciting company that is presently going through a major transformation. Concordia acquires, licenses and develops legacy and orphan drugs, mostly in the US. Since Concordia was listed on the TSX in December 2013 management has pursued a growth-by-acquisition strategy, and created tremendous gains for shareholders in the process. While early investors in Concordia have done very well to date, we believe that significant opportunities exist for the management team to continue adding value as global pharmaceutical companies seek to sell legacy drugs and re-focus energy on research and development.