Mackenzie Ivy Team
- Volatility returned to global stock markets in the fourth quarter, with an initial step down in market values in October that was followed by another in December. Over the course of the quarter, both the TSX composite index and the MSCI World Index generated negative returns.
- Although the drawdown in the market over the fourth quarter was certainly material and reflective of the many risks at play in the market today, it’s too soon to say whether it represents a harbinger of more to come or a pause in the continuation of a liquidity fueled bull market. We continue to position our funds, as we always do, carefully invested in a diversified portfolio of reasonably priced, high quality businesses so that we can participate in the long-term growth of the market while protecting our client’s capital through episodic periods of volatility.
Outlook & Strategy
What are the key opportunities you see?
- Our U.S. holdings held in quite well in the first bout of volatility in October but weren’t spared in December’s pull-back. We’ve seen some companies report results and some non-holdings like Federal Express and Apple have highlighted economic weakness while we’ve saw some holding companies like Nike highlight strong demand and delivering sold results. There is cost pressure in the U.S. in particular which is impeding the flow-through of solid demand to the bottom line. There wasn’t any significant activity in the quarter though we did reduce our Oracle position despite in-line results as the pace of the current stock buy-back gives us some concern. We have always felt comforted by the large net cash position Oracle has had on the balance sheet and seeing it move to net debt while the business in still in transition increases the range of potential outcomes and warrants a smaller position. We did add to UPS as growth concerns hit what we see as an already attractively valued stock though we recognize if we do see a recession the stock would likely move down by as much or more than the market. We won’t know how much of Federal Expresses growth issues were company specific until UPS reports results in late January and we won’t know the cost of delivering a strong operational peak season by way of higher expenses. It sounds like new capital investments helped and we expect to see better more efficient network performance going forward as UPS works their way through the network upgrade.
- The weak environment in Q4 led to some interesting opportunities to buy high quality stocks at what we believe are attractive prices, and we added four new European stocks to the funds during the past three months. The first was Husqvarna, a Swedish maker of chainsaws, trimmers, robotic lawn mowers, Gardena-brand garden equipment, and related products. Husqvarna has struggled in the U.S. for a while now, which has masked some very good and improving performance in Europe and elsewhere. They recently decided to walk away from a large portion of their U.S. business, which causes short-term disruption but we believe it is a positive step in the long-term. The stock price reacted negatively to these short-term issues, which provided an opportunity for investors with a longer-term perspective. Husqvarna is now a holding in Ivy European.
- DCC is a new addition to Ivy Europe and Ivy International. DCC’s core businesses of propane distribution (LPG) and gas stations, among others, don’t look obviously attractive at first glance, but the quality of the business is in its management culture, which excels at acquiring and operating businesses using a strong return-on-capital approach. This has led to an admirable long-term track record, which we believe can be sustained.
- For Ivy Canadian, the team initiated new positions in CCL Industries and TransCanada Corp, while meaningfully adding to our existing holdings in Encana and Premium Brands. We also opportunistically exited our positions in Procter & Gamble and Omnicom.
- CCL Industries is a global specialty packaging company and the world’s largest label maker. CCL’s strength is its ability to provide innovative, reliable, secure products for global supply chains, as a single accredited vendor. CCL services the largest global customers in the consumer, healthcare, electronics, automotive, and retail sectors, giving it exposure to several defensive end markets. We have admired CCL for a long-time, but had to remain patient until valuation multiples became compelling enough for us to invest. The share price corrected in the latter half of 2018 due to high polymer input costs and general market sentiment – both of which we view as temporary. Over time, we believe CCL will leverage its large global reach, deep customer relationships, manufacturing expertise, and materials science advantages to provide high quality, innovative label solutions. We expect CCL will use its strong financial profile to consistently reinvest in the core businesses, complete strategic acquisitions, expand manufacturing reach and capabilities, and take advantage of the trend towards premiumization in global label and packaging. We believe this will support strong organic growth and returns on capital, which will translate into above average share price performance.
- TransCanada develops and operates oil and gas pipelines, with the majority of its revenues derived from transporting natural gas. The company operates one of the largest gas pipeline networks in North America, moving a total 25% of continental supply on its system, and also owns the Keystone oil pipeline. Their network is concentrated in two of North America’s lowest-cost gas regions, which we believe will support future growth through continued production growth and the resulting demand for pipeline capacity. The company’s stable, recurring cash flow is supported by long-term, take-or-pay contracts that are negotiated in advance of construction to achieve attractive risk adjusted target returns without taking on meaningful commodity price or volume risk. Although TransCanada has a significant backlog of development projects, a key risk to our investment thesis is the growing social objection to pipeline development. This risk is partially mitigated by TransCanada’s weighting toward less controversial natural gas projects and rising demand for natural gas across North America.
- Since late 2016, rising long-term bond yields have driven TransCanada’s valuation multiple down in line with the low reached in 2009 and well below its historical interest rate-adjusted average multiple. This provided us with an opportunity to acquire a high quality, growing business with an attractive margin of safety.
What are key risks that need to be managed?
- Being careful on prices was particularly helpful this year, as it led us to remove or substantially reduce our positions in Sonova, Rotork, and TGS Nopec Geophysical, all of which corrected very sharply in Q4 after strong gains early in the year. When we sell positions due to elevated prices, we don’t do so with the expectation that they will soon decline. Rather, the high prices signal to us that the returns we can expect to earn by holding these stocks over the coming years is low and that there is greater risk of price correction. The fact that these stocks dropped shortly after we sold was simply luck, but is an example of how being careful on prices can be rewarded when the market environment suddenly becomes more risk averse.
- Apart from price, we will also occasionally sell stocks when we believe the original investment thesis has changed and the company no longer meets our quality hurdles. This was the case with Nokian Renkaat, which was a holding in Ivy European since 2014. Nokian specializes in winter tires, and has been remarkably profitable for many years. We have become increasingly concerned about long-term industry developments as well as changes in Nokian’s strategy, so we sold the stock in October
- Ivy has a long history of careful investing, and worrying is a key part of our DNA. We try to be careful about the businesses we buy, to be careful about the prices we pay for these businesses, and at times hold cash when prices seem excessive across the board. Sometimes, as in 2017, being careful in these ways proves detrimental to short-term returns. In welcome contrast, it paid to be careful in 2018, particularly in the fourth quarter.
- As we look out into 2019 we continue to believe cyclical growth remains overpriced on average and we see continued speculative elements in technology. It’s difficult to know how many new business models in the consumer and enterprise technology world are viable given such a generous fundraising environment but lower growth, higher discount rates or simply lower risk appetites may expose the answer soon.