TheBaron VI: Active February Brings New Strategy
Summary
- As the portfolio grows, I have begun to modify my investment criteria to initiate new holdings within low and medium yield companies to complement my high yield holdings.
- Some new investment portfolio moves, including exiting two major high yield holdings prompted by a recent short-seller article.
- New focus on companies I am equal parts familiar with, and confident in, including companies that are relatively high priced.
- Long-term focus is key to ensuring investor success, and diversification is key to consistent success.
We are quickly approaching the one-month mark between updates. Although I would very much like to continue to update twice-monthly, it would appear, at this point in the year, that once-monthly might be more realistic. Within this update, we will explore some of the portfolio changes I have made and introduce readers to a new suite of companies I have very recently added.
In order to prevent followers from being inundated with individual investment updates last week (when I did most of the portfolio maneuvering), this update will be the main disclosure for all February purchases, all sales were disclosed as they were done.
Portfolio Returns: Growth Through Net Cash Additions, Not Share Price Appreciation
My portfolio continues to grow well on the back of continued investment via the addition of new funds. With that in mind, I have been actively debating adding new holdings that will increase my portfolio's diversification. As it stands, my portfolio remains very aggressively invested into my high yield and highest conviction ideas.
As we move forward, I plan to lessen those holdings percentage of my total holdings through new additions to the portfolio, but not actively reduce the holdings sizes. The portfolio's returns over February is negative five percent (-5%) with a small reduction of -0.10% from my previous update.
Major Sale: Preferred Apartment Communities
The relatively weak return for February is a reflection of a poorly timed entry and exit of my investment in Preferred Apartment REIT (APTS) which has a strategy I like, but its high leverage and some of the larger dynamics in the industry proved concerning to investors across the REIT industry (and between the two apartment REIT picks of mine, I preferred the Morguard Residential REIT discussed in the next paragraph).
The largest change of the portfolio was allocating the funds I moved from Morguard North American Residential REIT to Preferred Apartment Communities back to Morguard North American Residential as its price trended below my cost and became too good an opportunity to pass up.
Major Reallocation: Morguard North American Residential REIT
Morguard North American Residential REIT (No US ticker, TSE: MRG.UN) has followed APTS downward during this REIT price weakness, though not as aggressively and, in my own mind, with nothing near the same justification (lower leverage and the strength of the managing partner should have insulated Morguard versus Preferred Apartment REIT).
The move downwards has been so overdone, I doubled down on the Morguard investment with all the proceeds from the APTS sale. Although there are fears related to the overall apartment industry within Canada and the United States, having Morguard as the managing partner and sourcing deals (MRG.UN has first option to purchase Morguard properties sold) allow for cross-border investments in the apartment REIT industry that few other companies with this kind of growth profile can claim. I am also most familiar with Morguard properties and its apartment management style, increasing my level of comfort with this company as my core apartment REIT holding at these prices. I also maintain the belief that apartment REITs will be one of the industry's best able to withstand a slow increase in interest rates and the flexibility to invest between Canada and the United States grants MRG.UN a unique ability to direct to area's where outsized returns are possible, without sacrificing the premium allocated to pure-play apartment REITs.
Main Holding Update: Village Farms International
Another major change and influence of the weak returns for February is my large investment in Village Farms International (VFFIF). Despite my own writing and my personal conviction in the long-term prospects of the company, the share price has stubbornly continued to move in tandem with other marijuana companies.
As I have documented twice in previous articles and through my investor updates, the company trades at a significant discount to its fair value with an impressive risk-to-reward trade-off.
For more information, I would recommend reading my two investment pieces on the subject (here and here), the latest investor presentation from Village Farms (here) and a private investment update from ENSO Research (note: I am not familiar with, or affiliated with, the company in any way) that argues that the company is worth more than it is trading today even if the marijuana license does not happen, plus more upside if approval occurs, using similarly conservative estimates to my own but in another style (here).
Portfolio Strategy Change
Prior to this update, my core methodology was rooted in four core tenants:
1) Current undervaluation from what I consider their current value based on all factors I consider. They are a good deal today.
2) They will likely continue that undervaluation over a time frame I am comfortable with, with catalysts for why that undervaluation will eventually disappear. I can continue to accumulate the investment for many years at a good value.
3) They allow me to re-invest in the companies relatively easily and with relative safety over time. Good dividend yield and/or relatively under-followed company.
4) They are currently severely undervalued and represent a short term, higher risk position that I follow in order to boost long-term returns, but that is not required for long-term investment success. Risky investments that keep things interesting, with a justifiable risk profile.
With these major tenants, they generally were leading to investments that were undervalued, traded lower than fair value on catalysts, and generated a good dividend. Lastly, I included a caveat to help keep my investing life interesting, an option to invest over the short-term when I find companies I find compelling over the short term. I would like to add one more investment philosophy.
Competitive Advantages and Systemic Growth Advantages
5) They are in a long-term sustainable industry (environmental or legislative) that protects the long-run growth prospects of the company, and that helps preserve the company's long-term business model advantages. This company, through its business model, has a sustainable competitive advantage that protects its growth long term.
As it stands, I invest heavily in companies that I believe have long-term growth prospects that I can appreciate, but my long-term investing horizon should allow me to purchase a variety of companies in a variety of industries. The thing is, there are few companies that operate in industries that I believe are sustainable long term, and many trade at valuations that I find aggressive.
The reason I have decided to include that style of company, regardless of current valuation, is due to my belief that I need to invest in (and track) these companies for continued purchases over my investing lifetime. Should the companies become terrific deals on a valuation basis, I will bang the drums online and with my own funds, but I wish to invest and own these great companies now (in case they always trade at premium valuations).
6) Ensure a small, but consistent, allocation to ETFs and other products that give the overall portfolio a mix of diversification, and concentration, to regions of the world I feel may benefit from continued systemic growth advantages that should generate superior long-run returns. Invest in ETF products that I believe will outperform over the long term to add to overall diversification.
In order to increase my portfolio's diversification, and in keeping with my renewed focus on long-term investments, I would like the portfolio to begin to open positions in countries and regions of the world I believe can produce outsized returns due to compensate for my portfolio's over-sized concentration on the United States and Canada. I need more international exposure, and I have decided to, at least temporarily, focus on ETF products focused on India and China.
Portfolio Allocation and Discussion
As it stands, the portfolio has grown to 10 positions, although the top four carryovers still represent 73.07% of the overall portfolio. These top four positions are simultaneously my highest conviction ideas, and three of the four will continue to grow through dividend reinvestment (DRIP) without further allocation of new funds (pending a major correction).
Strong performance of Medical Facilities has allowed it to grow to my top position, along with recent price recovery of Village Farms as rumors of facility approval push shares higher has brought it up to my second largest position, and Northwest Healthcare and Morguard Residential have been relatively weak but continue to grow from DRIP reinvestment.
There have been three major sales, with Preferred Apartment Communities discussed earlier. There was a short report on one of my portfolio companies, and it prompted my sale of two companies to help fund my purchase of my new holdings. We will discuss that here for those that missed my blog post updates.
Major Sales: Crius Energy Trust and Brookfield Real Estate Services Exit
Crius Energy Trust (OTC:CRIUF) was a new addition that I was initially planning to hold for the long term, but a short report left me re-evaluating my position in the company. Although that report brought nothing new to the table aside from some accusations about company management (which was rebuked by the company in a press release), it caused me to pause. I have always strongly believed that short-sellers, due to the high risk nature of their investment, need to have some of the strongest due diligence in the industry. That is not to say that they do not sometimes target a company, like Crius, that simply through its business model and circumstances was ripe for a short article.
As I was reading the article, I realized I did not have quick responses to the concerns being brought up, as my own due diligence was largely based on the work of others due to some time constraints over the last month. I have not published an article on Crius Energy because I did not find the time, making me ill-prepared for the short article. I realized that I did not know the company well enough to own it, and reacted by selling my shares about 10 minutes before the carnage started.
This realization made my re-evaluate my positions in my major holdings, which prompted me to exit another of my positions, Brookfield Real Estate Holdings (OTCPK:BREUF). Although its business model is an interesting one, and I see it as undervalued, I simply was not familiar enough with the business to keep holding.
Those who are curious might ask, "Where did my time I normally allocate to investments go over the last month"? it has gone almost completely into deciding whether I would change my strategy and add other companies that I had been spending my time researching. As I was also actively considering a change of strategy in my portfolio as, through new additions, it has grown to the point I feel that more diversification is necessary. New funds, plus those from Crius and Brookfield Real Estate all helped fund the new positions I added to companies I had been spending my time exploring and find more interesting.
New Long-Term Addition: Clearwater Seafoods Inc.
Clearwater Seafoods Inc. (OTC:CSEAF) is a company that I have been following for years. It is in the seafood business, with a particular focus on sustainable, wild caught populations of different seafood. It is vertically integrated and has been spending years investing millions into acquiring the rights (and equipment) to sustainably catch and sell seafood across the world.
At the moment, the company has been beaten down to what I believe to be excellent prices on the back of seafood pricing weakness and a lower-than-normal harvest for this year. Both should be temporary setbacks, as the demand for both high quality, and sustainably sourced, sources of protein should continue to grow disproportionately over time. This company has the added benefit of a strong, DRIP-able (for Canadian brokerage accounts) stock with strong future prospects on the back of favourable supply and demand fundamentals in their industry. Further weakness might continue, but this company and its model makes me confident in continuing to acquire it during this downturn.
New Short-Term Addition: Norbord Incorporated
Norbord Inc. (OSB) is one of the largest and most profitable operators in the OSB industry. Although the benefits and high margins of OSB are well known, this company is a shorter-term investment to complement my next largest holding to be discussed next. The fundamentals for housing and new housing construction is hard to know for certain, but operators like Norbord are well positioned to capitalize on the trend of replacing plywood with OSB (from what experience I have in building construction this is a trend I see continuing over time) along with high-margin, high ROE growth centered around continued home building (should that trend continue). Although no one is certain which direction the housing market will turn, this is my leveraged play in continued strength in the industry in an undervalued, high dividend and DRIP-able investment in the space.
New Long-Term Addition: West Fraser Timber
West Fraser Timber (WFTBF) thus far has appeared to be the most interesting vertically integrated timber producer. Although I would not argue the company is cheap, it operates in a sustainable industry that should continue to benefit from the larger trend of continued wood application in building and construction. Although some of its industries, like the pulp industry, may be facing some long-term issues in sustainability due to computerization, the building and materials applications are simply too environmentally friendly to not continue to operate as a major industry.
Larger trends, such as the increased use and acceptance of wood construction for homes outside of North America, coupled with continued innovation in utilizing wood for high-rise construction projects, we should see wood-based products continue to command market share in the world market for construction, furniture, packaging and paper-based industries. I also enjoy West Fraser's focus on multiple product lines and sustainable business practices, though admittedly I need to continue to explore the major forestry companies to decide on the best long-term operator, at this time, it stands as West Fraser.
This company is, coupled with my next pick, one that should continue to operate many years from now with a growing dividend that appears low now but will have a yield on cost when I approach retirement that will make my patience and continued allocation worth it.
New Long-Term Addition: Canadian National Railway
A long-term favorite of many investors across North America Canadian National Railway (CNI) is one of the best operated companies (looking at efficiency) of all railway operators. Although the Berkshire Hathaway owned railway might eventually give them a run for their money, this Canadian stalwart has spent most of its operational history showcasing the strength of a near-monopoly, combined with a strong and continued focus on operational excellence.
The company's relative weakness lately is due to a variety of short-term factors, including some issues related to grain shipments, employee shortages/labor issues and worries about unsustainable oil-shipments (which carry a premium). The fact is this company's history and the systemic advantages of carry goods this way make it highly unlikely that these issues will affect the long-term prospects of this company. Rail is the most efficient way to transport many of the products we use every day, and there is nothing coming down the road to make me believe this will change in my lifetime.
As to the other concerns brought up, the issue of grain shipment issues has been a long-term issue, as grain will wait, and there are always more profitable goods to ship. This seems callous, and farmers are right to be angry about it, but the government largely stopped interfering during the decade that the Harper Administration was in charge, and if the Liberal government decides to do something I imagine it will be largely favourable to Canadian National.
Canadian National, in its defense, is suffering from a shortage of equipment and trained personnel which it is trying to rectify (with regards to grain shipments and other goods). It is a terrific capital allocator, so I believe it will very efficiently raise its service levels over time unless forced to do otherwise by the government, which I do not have an issue with either if deemed necessary.
The oil shipments providing a near-term, largely unsustainable increase in net income are where I think the short-term gains will be made. The fact is that many provincial governments in Canada are not interested in growing oil shipments by pipeline, and that oil needs to be moved to market, forcing Canadian junior and intermediate oil producers to rely on rail to move oil to refinery capacity. I am emboldened in the view this will continue to generate outsized revenue and net income for the future that will facilitate continued re-investment in the core business, dividend growth, and share buybacks while it lasts.
The Liberal government is very pro-pipeline (despite what you might have heard, unless you are an environmentalist like myself in which case you may have heard that already), but unless the dynamics change in the provinces (which are now largely left-leaning), there is no reason to believe pipeline capacity will increase meaningfully to upset this trend. Note that this is not anywhere near a positive for Canada overall, but it is good news for Canadian Railway, and I believe it will continue to have this income discounted due to its probable short-term nature in the eyes of industry analysts, allowing those that share my personal belief that it will continue well into the future to add below their fair value.
Conclusion
As I continue on my journey to retire with a collection of companies who will generate outsized returns, I would like to speak a short while about my renewed focus on some investment concepts I use to help choose investment ideas. Currently, I am very focused on relatively high return on equity, reasonable leverage, the relationship between gross margin to share price to distributable cash. I invest in companies that will (hopefully) be around a long time, have catalysts in the future I believe could help improve valuations and have something short-term that might be temporarily affecting the price.
Although there are thousands of companies to invest in, I believe that selecting future-proof companies that will generate income and growth over my lifetime is important to a sustainable portfolio. I also believe that a company operating in an industry like the ones I focus on should be able to generate, and distribute, its ample cash to its investors with which to re-invest when an investor is young and live off of as the investor gets older.
Although I generally use some time in each update to speak to the future companies I would like to analyze further for investment, for the sake of time, I believe I will leave that discussion to next time since there was so much action in the portfolio over the last month.
Thanks for reading, and happy investing.
Authors Note I: Please consider following. All investment purchases are updated via Blog Posts and/or in Investment Updates like this one. As I do my best to avoid trading too actively in the account, I will try not to inundate followers with those types of posts.
Authors Note II: All images are taken from the official websites of the companies discussed.
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
This article was written by
Analyst’s Disclosure: I am/we are long PORTFOLIO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I am long all products disclosed through Canadian exchanges. Please keep in mind most companies discussed are relatively small and trade with better liquidity on the Canadian exchanges.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
Recommended For You
Comments (6)
----------------------...In the wake of the sudden departure of Canadian National Railway (CNR-T;CNI-N) chief executive officer, RBC Capital Markets is cutting its price target on the railway."We attribute the company's operating issues as a result of too much growth, too quickly; culminating in the Board decision to replace the CEO. The focus now will be on rebuilding executive leadership and grinding through congestion issues. We advise investors be opportunistic as we maintain our positive view on the company's core asset base and the attractive dynamic of the industry in which it operates," said analyst Walter Spracklin." CN's Board announced the immediate departure of Luc Jobin and has appointed JJ Ruest as Interim President and CEO. The move comes as a result of significant congestion-related operating challenges that began in H2/17," he said." We believe that following years of successful cost cutting, the company (appropriately) shifted focus to customer service improvement and growth. Unfortunately, in 2017 that growth went into overdrive, leading to volume increases that were above what the company could manage. This in turn led to severe congestion and a deterioration in customer service. Correcting the issue would not prove cheap: more workers, more locomotives, more capex. Unfortunately this has been aggravated by high levels of customer dissatisfaction as YTD volumes trended down -6 per cent (versus industry average of +2 per cent)," he said."Two key areas of investor focus are now important. First will be rebuilding the leadership team through the selection of a new CEO. Second will be the company plan to address the near term issues of congestion and disrupted service. In the meantime, we expect the company's profitability growth to be interrupted and we see both the company's 2018 and long-term guidance as likely to come under review," the analyst said."CN has incurred volume declines YTD of -6 per cent, which is below the +4 per cent that we had forecast and worse than the level anticipated under management's full-year +3 per cent to +5 per cent guidance level. We believe higher than anticipated costs have also come into play, resulting in a hit to near-term earnings. Accordingly we are bringing down our 2018E EPS growth to +1 per cent (from our previous 8 per cent and the 5 per cent to 8 per cent guidance). We are assuming that the worst comes in the near term and that the company does begin to realign itself to resume growth in 2019."He cut his price target on the railway's TSX-listed stock to $105 from $112 on the back of the lower estimates. He maintained his outperform rating. The median price target is $108.82, according to Zack's Investment Research."The issues currently facing the company in our view are not systemic. We continue to view the company positively for its high quality asset base, operating in a very attractive competitive environment. We believe value investors should take advantage of any near term weakness."
