2015 In Review

Jan. 15, 2016 1:04 AM ET
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Value, Special Situations, Utilities

Contributor Since 2014

Canadian CFA Charterholder that researches mostly small-cap firms in a number of industries in my spare time. My professional background is primarily in the utilities industry, so much of my research will be focused on that segment. In the past, my research has mostly driven my own portfolio, but I am looking to share this research with a wider audience, mostly out of personal interest.

Another year has come and gone and in this piece, we'll take a look back at our 2015 picks and see how they've performed up to the end of the year. Afterwards, we'll dive into our 2016 outlook for North American equity markets.

Capstone Infrastructure (MCQPF) - BUY

This firm had some ups and downs throughout the year, ending with a big up. The Bristol Water regulatory process was more or less in line with median expectations which provided some certainty and stability to the company's cash flows going forward. In addition, execution on the project portfolio seems to be moving along according to plan, offering the future cash flow growth required to drive the our valuation target.

That all said, the biggest news was in early November when the firm announced that they had hired Toronto-Dominion Bank and the Royal Bank of Canada to advise on a possible sale. While news has been scant since, as expected, we believe that our valuation target of $4.90 per share is reasonable, and this means the firm is an attractive takeover target. It's unlikely we'll see a bid as high as $4.90 due to the recent trading price history, but we do think there is still some moderate short-term upside in this one as the possible transaction pans out, and if nothing happens, there is enough long-term growth potential for us to want to own this stock moving forward.

Price when published: US$2.37

Price on December 31: US$2.60

Performance to date (including dividends): Up 16 percent

Surge Energy (OTCPK:ZPTAF) - BUY

Surge Energy has been the case of a strong performer in a terrible industry over the last several months. While the company continues to execute at a high level on its drilling program, the drilling program has had to be scaled back as crude prices continue to languish. Along with this, the dividend was reduced, though the company is also continuing to buy back shares. This is a strategy we applaud, as the firm appears to be buying back shares with a much higher NAV than the current trading price. We believe this company is undervalued, so we're happy to see the share count reduced at these levels.

Surge remains one of our largest holdings as we anticipate some stability and upward momentum in crude prices next year. Nevertheless, it's a fool's game to predict oil prices, in either direction. Having modest exposure to the sector in a diversified portfolio makes sense, and with Surge you're getting top notch management and a great asset portfolio. There is takeover potential as well if prices stabilize in coming months.

In all honesty, given the last five months of oil price movements, being down 10 percent on an energy holding (with dividends factored in) is not a bad place to be.

Price when published: US$1.80

Price on December 31: US$1.54

Performance to date (including dividends): Down 10 percent.

Dream Global REIT (OTC:DUNDF) - BUY

This undervalued REIT continues to be one of our top picks based on inherent value and where it's currently trading in the market. While the portfolio went through some growing pains as it diversified away from a single customer model and worked to upgrade the quality of the portfolio, it's now reaping some of the wins from that. The REIT has posted an improving occupancy rate and much improved rents per square foot. We expect this momentum to continue in its sole market, Germany, which has a fairly positive economic outlook given the global picture today. Increasing rents per square foot, increasing occupancy, increasing cash flow for investors.

One risk that's on our radar here is the potential for EUR devaluation to occur versus CAD (which the reporting currency of the entity). The risk also exists for U.S. investors indirectly with further EUR deprecation against USD. While the REIT hedges its cash flow to maintain its dividend and interest payments, the balance sheet looks to be unhedged, so there is some FX exposure. We do expect CAD to be modestly stronger in the coming year, so keep an eye out for this risk.

Price when published: US$7.38

Price on December 31: US$6.29

Performance to date (including dividends): Down 11 percent

High Liner Foods (OTCPK:HLNFF) - HOLD

This Canadian based but North American focused seafood retailer has experienced some pains over the last two quarters. Results have been below expectation as the firm struggles with a combination of higher input costs and a weakening Canadian dollar. The firm reports in U.S. dollars, so Canadian based sales are contributing less to the U.S. dollar bottom line. In generally, firms with Canadian dollar revenue have struggled purely on the near 20 percent currency devaluation versus the greenback in 2016.

That said, we believe that this remains a quality company, with several good brands. The company is not overextended, produces solid EBITDA numbers and has maintained its revenue numbers despite the tough currency environment in its key market. We're not recommending buying just yet at these levels as a recovery in price may be some time away, but we are not compelled to sell this short yet either. We believe that High Liner will post a recovery in 2016, but not one that makes it a top pick any longer.

Price when published: CAD$18.03 (thinly traded on OTC US Markets, TSX price given)

Price on December 31: CAD$15.55

Performance to date (including dividends): Down 14 percent

Abengoa Yield PLC (ABY) - BUY

Abengoa Yield PLC has certainly been one of our most volatile picks in 2015, with the sponsor company, Abengoa SA (ABGB), struggling on the brink of bankruptcy. Despite the sponsor's troubles, Abengoa Yield maintains a reasonably levered portfolio of high cash flow producing assets, and the market seems to have moments of clarity on this fact, this in between the negative headlines tagged with Abengoa's name. As a result, we see recoveries offset by declines when bad news about the sponsor comes out. This, in our view, offers good entry points for a long-term holding in Abengoa Yield.

The company is actively seeking a new sponsorship deal and if announced, will give the firm a significant boost. We believe this upside, paired with a floor price more or less at these levels anchored by the inherent cash flow of their existing assets, makes Abengoa Yield a top pick heading in 2016.

Price when published: US$18.41

Price on December 31: US$19.29

Performance to date (including dividends): Up 7 percent

NextEra Energy Partners (NEP) - BUY

Another energy infrastructure play, NextEra Energy Partners is a diversified YieldCo with both electricity generation (wind and solar) and a midstream pipeline business. Again, we're seeing the YieldCo space hit hard in the past few months, with concerns over the ability to raise high yield debt to financing new growth acquisitions. Despite these challenging conditions, NextEra has been able to post some significant gains since our recommend, and we retain a buy rating on this stock. We'd be sellers around the U.S. $35-37 per share mark this year, with macro concerns probably putting a ceiling on this stock in the short-term.

Price when published: US$25.99

Price on December 31: US$29.85

Performance to date (including dividends): Up 16 percent

Westshore Terminals (OTCPK:WTSHF) - HOLD

Westshore Terminals was a stock where we admittedly got the timing dead wrong. With two customers now announcing that shipments will be reduced, it appears less likely that Westshore will be able to fully utilize its new facility expansions in the immediate term. Unfortunately, the global energy commodities market, including coal, has been hit hard and continues to struggle with depressed prices. A recovery in prices and therefore a return to exporting for some of the customers will drive this stock quickly higher, but there is little confidence of that occurring in the coming months.

Investor and Canadian business icon Jim Pattison, the largest shareholder of Westshore, is still buying shares which points to insider confidence in the firm. And with a very long-term view on this stock, we agree. However, with a tough coal market outlook for the next several years, this stock can only remain at a hold rating. We like the value at these prices, but we're not convinced the catalyst to move this back north of US $15 per share will occur in the short term.

Price when published: US$19.96

Price on December 31: US$8.42

Performance to date (including dividends): Down 55 percent

Macquarie Infrastructure Corporation (MIC) - BUY

Macquarie Infrastructure Corporation has several high quality infrastructure and infrastructure like assets that produce long-term stable cash flow. This has enabled the company to pay a significant distribution, and one that we believe will be able to be increased in the near future (including an announced increased in the Q3 results). This view is based on a currently low payout ratio and organic growth in the existing portfolio companies. Performance remains impressive in the portfolio businesses, especially the high EBITDA growth realised in the past year.

One interesting note: when we published our article, a few readers indicated they were concerned by the lucrative management fee charged by Macquarie to run this fund. However, the biggest component of this management fee is based on performance versus various benchmarks. As the company has underperformed in Q4, the management fee should be significantly reduced for the quarter.

Macquarie remains a strong buy recommendation for us, especially at levels lowers than when we initially issued the recommendation. We stand by our initial price target of $93.70 per share. This growing, yet yield focused, play is poised to offer long-term investors significant rewards for staying on board through a turbulent patch in 2015.

Price when published: US$79.78

Price on December 31: US$72.60

Performance to date (including dividends): Down 8 percent


Our most recent recommendation, our short call on Loblaw has been moving in the right direction over the month of December. Our view remains the same, that Canada's leading food retailer is stuck in the middle of higher end retailers taking business away on one side, and discounters and wholesalers taking away the low cost consumer on the other. We struggle to understand where Loblaw will get its "next" customer.

On top of this, the company has not been able to control costs or maintain same-store sales at the price of food inflation. While we don't think that Loblaw is in any immediate danger as a company, we don't believe that the implied growth in the valuation will be realised and that investors will need to see a significant P/E compression in the stock in the coming year. We remain bearish on this one, and retain our short call.

Price when published: US$50.43

Price on December 31: US$47.18

Performance to date (including dividends): Up 6 percent (stock down 6 percent with dividends)


In total, our picks produced an average return of negative six percent this year (does not factor in different holding periods or weightings, just a simple average of the returns on our picks). While we are not happy with the absolute return of the picks since August, in comparison to the S&P 500 we are only trailing the index by approximately 3 percent. The one considerable negative contributor to the portfolio was Westshore, and excluding that one pick actually brings us into slightly positive territory on the year. Given the small cap focus of our portfolio, we aren't surprised that we have realised a beta of greater than one. On the upside, we believe that positions us well to see outsized gains upon a recovery.

Heading into 2016, we do expect a period of extremely volatile equity prices. It's going to be important for investors to focus on the underlying cash flows they are buying, such as with Abengoa Yield or Macquarie Infrastructure. Try to look away from the price volatility and focus on buying solid, reliable long term cash flows. In five years, the volatility is not meaningful so long as you're not drawing down your portfolio.

This leads us to our overall macro view for 2016: speculative sectors, like tech, will be risky plays as we start having some realism pumped into the market with monetary tightening in the U.S. Multiples will likely decline. A focus on high cash flow, low earnings multiple stocks (not paying for growth that is unlikely to occur) is what we're going to do in 2016, and we hope to bring you more investment ideas for discussion and debate in the year ahead.

Thank you,

Spy Hill Research

Disclosure: I am/we are long MCQPF, ZPTAF, ABY, NEP, MIC, DUNDF.

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