Brendan Caldwell, president, chief executive officer and chief investment officer, Caldwell Investment Management

FOCUS: North American large-cap stocks  

MARKET OUTLOOK:

Elevated inflation has forced North American central banks to quickly and aggressively raise interest rates, which has three negative effects on the stock market. First, from a risk versus reward perspective, equities become less attractive relative to bonds. Second, bank lending slows, large capital projects are scrapped and consumer spending moderates. Third, higher-valuation stocks become less valuable as future profits are worth less today. Additionally (and related to number three), as higher rates increase the odds of a recession, investor positioning shifts away from higher valuation growth tech companies towards more defensive stocks and sectors.

Because tech held such a large weighting in many major indices, a rotation out of these stocks is exacerbating the magnitude of the sell-off. We believe the environment will remain challenging going forward, however, market sell-offs can provide opportunities to invest in quality companies at attractive valuations. To that end, we will continue to focus on identifying high-quality, well-managed companies with proven histories of navigating through tough environments and believe professional investment advice can be extremely valuable in times such as these.

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TOP PICKS:

McKesson (MCK NYSE)        

 Mckesson is one of the largest distributors of prescription medicines and surgical supplies in the U.S. It should benefit from rebounding prescription volumes as more people resume routine doctor visits. The company recently exited the majority of its margin-dilutive international business which should improve profitability and management focus over time. Lastly, sale proceeds from the international business could be used for organic growth initiatives, such as biopharma services, which is a small portion of revenue today but growing two to three times the core distribution business, or capital returns to shareholders.

•  What do they do?
  • A leading wholesale distributor of prescription drugs and surgical supplies in North America
  • ~1/3 of the wholesale U.S. prescription drug market
  • Also serves as the U.S. government’s centralized distributor for COVID-19 vaccines (contract was recently extended another year to July 23)
• Why do we like them?
  • High barriers to entry in this market given strict regulatory requirements – top three players are ~90 per cent of the market
  • Scale benefits allow MCK to negotiate favourable discounts on drugs; scale also ensures consistent and reliable delivery which supports customer retention
  • Aging population provides long-term growth tailwind given its disproportionate usage of prescription meds
  • In the near term, prescription volumes are rebounding as consumers resume regularly scheduled doctors’ visits
  • MCK exited the majority of its margin-dilutive international business which should improve profitability over time
  • Divestiture proceeds can be used to fund organic growth initiatives, such as biopharma services, which is a small portion of revenue today, but growing two to three times the core distribution business

Tractor Supply (TSCO NASD)

TSCO is the largest rural lifestyle retailer in the U.S. serving ranchers, contractors, and full and part-time hobby farmers, among others. Industry-leading sales growth is supported by urban-to-suburban and rural migration, disproportionate exposure to higher-income consumers and a product mix skewed toward “need-to-have” versus “nice-to-have” products. A loyalty program developed under the company’s new chief executive officer has gained significant traction in a short period of time, with strong retention rates and higher spending from members versus non-members. Adding garden centres to existing stores expands TSCO’s total addressable market and should support growth rates over time. Lastly, investments in "big and bulky" distribution capabilities further distance TSCO from smaller peers that cannot offer bulk quantities, same-day delivery, etc., which should drive market share gains over time.

• What does it do?
  • The largest rural lifestyle retailer in the U.S. serving ranchers, contractors and full and part-time hobby farmers, among others
  • 2,200+ stores across the U.S
  • Core customer typically skews toward above-average incomes and lives in below average cost of living areas
• Why do we like it?
  • Industry-leading sales growth is supported by urban-to-suburban and rural migration, disproportionate exposure to higher-income consumers and a product mix skewed toward “need-to-have” versus “nice-to-have” products
  • 50 per cent of revenue tied to livestock and pet products, primarily livestock feed and bedding; pet food, bird seed and seasonal products like fertilizer, pest and weed control
  • A loyalty program developed under the company’s new CEO has gained significant traction in a short period of time, with strong retention rates and higher spend from members vs. non-members
  • Adding garden centers to existing stores expands TSCO’s total addressable market and should support growth rates over time
  • Investments in "big and bulky" distribution capabilities further distance TSCO from smaller peers that cannot offer bulk quantities, same-day delivery and more, which should drive market share gains over time (HD did the same vs. Lowes a couple of years ago and has built a considerable lead serving pro customers)
  • Lastly, these investments (and supply chain issues) have pressured margins over the last little while; TSCO is nearing the peak of its investment cycle which should provide a tailwind to margins going forward 

Carlisle Companies (CSL NYSE)

Carlisle is a global manufacturer of engineered building products and high-performance cable and interconnect products used in commercial and residential construction, aerospace, defence and medical device end markets. The outlook for non-residential construction spending is robust given a backlog of projects built up during the pandemic. Management has good foresight into commercial replacement roofing demand longer term and these projects are generally non-discretionary which provides solid revenue visibility. CSL also continues to move its construction material product portfolio upmarket which allows the company to capture better value and margins and move away from more commoditized products. Management has a track record of pruning non-performing businesses while acquiring leaders in adjacent industries that improve its total addressable market. Lastly, the commercial aerospace industry is expected to gradually recover which should benefit CSL’s interconnect business over the medium term.

• What it does?
  • A global manufacturer of engineered building and roofing material products used in commercial and residential markets
  • Also makes high-performance cable and interconnect products used in the commercial aerospace, defence and medical device end markets
• Why we like it?
  • Outlook for non-residential construction spending is robust given the backlog of projects built up during COVID
  • CSL fully booked for 2022 and starting to take orders for 2023; management has good visibility into commercial roofing demand in the longer-term
  • Commercial replacement roofing demand is largely non-discretionary, and less cyclical during downturns
  • From an ESG perspective, upgraded roofing systems can improve building efficiency and energy usage, which is very topical in the current environment
  • CSL’s management continues to move the product portfolio upmarket, which allows the company to capture better value and margins and move away from more commoditized products
  • Continued portfolio optimization speaks to management quality:
  • A recent acquisition in the residential weatherproofing and building envelope category expands total addressable market while shedding lower margin/return business units
  • The commercial aerospace industry is expected to gradually recover which benefits CSL’s interconnect business

PAST PICKS: December 21, 2021

Texas Instruments (TXN NASD)

• Then: $186.37
• Now: $157.91
• Return: -15%
• Total Return: -13%

Motorola Solutions (MSI NYSE)

• Then: $261.61
• Now: $244.50
• Return: -6%
• Total Return: -5%

Church & Dwight (CHD NYSE)

• Then: $98.40
• Now: $75.84
• Return: -23%
• Total Return: -22%

Total Return Average: -13%