Stephen Takacsy, president, chief executive officer and chief investment officer, Lester Asset Management

FOCUS: Canadian stocks  

MARKET OUTLOOK:

Equity and fixed-income markets have been volatile so far in 2023 on fears of further rate hikes, recession, and the recent failure of a few small regional banks. We believe that this volatility has presented some excellent buying opportunities in both stocks and bonds. In equity markets, only a handful of tech stocks have been responsible for most of the rise of the S&P 500, with the rest of the market lagging miserably, despite a strong economy and generally good earnings. Small-mid cap stocks in particular provide compelling valuations trading well below intrinsic value. In fixed-income markets, higher-yielding corporate bonds are very attractive providing “equity-like” returns of six per cent to eight per cent. Investors should really take advantage of this unique opportunity since high rates won’t last as inflation is coming down fast (as we saw in the Canadian inflation data recently), with supply chain issues easing, demand softening, and input costs like commodity prices coming down. We believe that the rate hiking cycle has come to an end in Canada and the U.S., although central banks will continue to talk tough to get inflation back down to two per cent. If there is a pronounced recession or more turmoil in the banking sector, central banks may even cut rates if needed, which would cause a rally in both stocks and bonds.

We believe that in Canada and the U.S., there will be a “soft landing” as those economies remain strong with low unemployment. Investor sentiment has been bearish which is a great contrarian signal, and as we know when sentiment starts to turn positive, markets usually rise sharply. This is why it’s important to stay the course. We remain nearly fully invested, but well diversified in recession-resistant businesses that are generating record profits. We also own many safe high dividend-yielding stocks like telecoms, pipelines, utilities, and banks which look particularly very attractive at the moment. We also own companies benefiting from long-term trends such as aging demographics (Savaria, Park Lawn, Neighbourly), digitization and automation (CGI, Tecsys, and ATS), and infrastructure (Stella Jones, AG Growth, Logistec). We continue to take advantage of volatility to add high-quality companies at more reasonable valuations as share prices come down to attractive levels, such as Colliers International and Altus Group, and CCL.

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TOP PICKS

QUARTERHILL (QTRH TSX)

Quarterhill is a pure-play leader in intelligent transportation systems.

Quarterhill had two businesses; an IP patent licensing portfolio known as Wi-LAN which was finally sold a few weeks ago, and an Intelligent Transportation Systems (ITS) business. So, the company is now a pure play ITS solutions provider and is a leader in electronic toll lanes in the U.S based in Texas and a world leader in traffic enforcement, data collection, and weight-in-motion technology based in Saskatchewan.

The ITS business currently has a record backlog of around $800 million and a robust 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. Now that the company is a pure-play ITS leader, the stock has started attracting the attention of institutional investors and is likely to command a higher valuation going forward. The stock has performed poorly due to low margins during the implementation phase of new ITS projects, but results are expected to significantly improve over the next few quarters as high-margin recurring revenue kicks in. We and other shareholders have also been pressing the board to add stronger and more experienced directors to oversee a new soon-to-be-hired CEO which is now underway and should lead to some meaningful insider buying as well. We expect the stock to go back over $2 between now and year-end.

POLLARD BANKNOTE (PBL TSX)

Pollard Banknote has top-line growth and margin expansion.

Pollard is the second-largest supplier of instant printed lottery tickets in the world and a leader in electronic lotteries in the US (iLottery). There are only three players who print instant tickets for governments in North America and Europe, so barriers to entry are huge. The instant ticket market has been growing for decades and continues to grow as governments need revenues from lotteries. Pollard’s share came down last year because of inflation on input costs such as paper, ink and foil which rose sharply and could not be passed on because contracts with government lotteries are for a fixed price. However, these contracts are now being renewed at significantly higher prices, which is easy to do because the cost of a printed ticket is only one per cent of the total cost to the government, the prize money being by far the biggest cost. Pollard has now renewed over 50 per cent of its contracts at higher prices. The company expects strong sales growth from instant tickets and iLottery as more states adopt electronic lotteries, combined with strong margin recovery on ticket sales. This should lead to record profits over the next few years. Note that Brookfield Business Partners paid US$6 billion or nearly 14X EBITDA for Scientific Games’ instant lottery business in 2021, which would value Pollard at over $40 per share. The stock is currently a bargain trading at under nine times EBITDA.

AG GROWTH (AFN TSX) 

AG Growth is a safe way to play global growth in agriculture.

AG Growth is a leading global manufacturer of handling and storage systems for grain, fertilizer, and other commodities for the agriculture industry. The company announced record results in 2022 of nearly $1.5 billion in sales and record EBITDA of $235 million. It recently increased EBITDA guidance to $265 million for 2023 based on a record backlog and strong demand from international markets such as Brazil, India and Eastern Europe as these regions are investing heavily to upgrade their farming infrastructure. This is a great way to play the global agriculture sector without taking commodity risks. The company is also generating significant free cash flow and is deleveraging quickly which is another tailwind for the stock price. Even though the stock is up over 50 per cent in the past year, it still trades at a bargain of less than seven times forward EBITDA. We estimate that AG Growth is worth as much as $90 per share if sold to a strategic buyer like AGCO, a large U.S. competitor.

Past Picks: June 6, 2022

SAVARIA (SIS TSX)

• Then: $14.49
• Now: $16.57
• Return: 14%
• Total Return: 18%

JAMIESON WELLNESS (JWEL TSX)

• Then: $38.06
• Now: $29.91
• Return: -21%
• Total Return: -20%

BORALEX (BLX TSX)

• Then: $41.63
• Now: $36.29
• Return: -13%
• Total Return: -11%

Total Return Average: -3%