James Telfser, partner and portfolio manager, Aventine Investment Counsel

FOCUS: North American stocks 

MARKET OUTLOOK:

 We find ourselves in a period where near-term growth and earnings expectations continue to decelerate for both the economy and individual companies. Despite continued hawkish commentary by central banks, inflation continues to moderate and we are now left to estimate the lagged impact of monetary policy decisions on corporate earnings. Markets loathe this type of uncertainty and as a result, we expect heightened volatility throughout the balance of the year.

Across our strategies at Aventine, we hold best-in-class businesses across all sectors and we are not concerned about our holdings’ ability to manage through any potential economic weakness. In fact, in many cases, valuations look quite reasonable, especially if we continue to see inflation fall, as is our expectation. We recommend investors with longer time horizons take advantage of any volatility-induced valuation discounts by deploying a portion of their above-average cash balances which have built up over the past year.

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TOP PICKS

Nintendo (NTDOY OTC)

In this market, we advocate keeping it simple while focusing on fundamentals and valuation, not headlines. This approach tends to favour misunderstood stories. Most people know of Nintendo as a hardware platform which owns some well-known IP. The stock has suffered recently due to the gaming sector hangover resulting from strong growth during COVID-19, as well as the Switch platform posting its first sales growth decline year-on-year in its history. However, the company has undergone a dramatic transformation and the Switch is now not only a platform to play games, but to purchase them, too. This has resulted in software sales being a much higher proportion of total sales. As a result, Nintendo’s operating margin has increased from six per cent in 2017 to 35 per cent today, without a meaningful increase in its multiple. The next-generation Switch will result in an increase in third-party game availability leading to margins approaching 50 per cent. The company has no debt, trades at a P/E of 12x (net of cash) and sports a solid dividend yield (2.25 per cent). Finally, the recently released Mario Bros. movie has set the highest-grossing box office so far in 2023 which could set the stage for the company to further leverage their game franchises while diversifying its revenue.

FirstService (FSV TSX)

FirstService is North America’s largest residential property management company but also operates several related brands in industries such as restoration, home improvement and fire safety. We have always liked the fact that most of its business lines are highly fragmented, setting up a highly predictable and profitable capital recycling program. Organic growth has been solid over the years and, with reasonable assumptions regarding acquisitions, we believe you could see 10+ per cent top-line growth in 2023. It has a solid balance sheet with the ability to deploy significant capital on mergers and acquisitions, beyond that the growth profile is attractive. We believe FirstService offers a rare combination of stability, growth, and catalyst potential. When you add in its best-in-class management team it is not surprising that the stock is rarely considered undervalued.

Element Fleet Management (EFN TSX)

Element Fleet is one of the world's largest fleet management companies, and we believe the company is set up for success over the medium term. With aging existing fleets and a robust backlog, there is considerable pent-up demand for both services and vehicle replacement. With auto OEMs struggling to produce new vehicles recently due to supply constraints, there is a steady stream of contracted orders to fulfill irrespective of the economic landscape. Element currently generates a significant amount of free cash flow (~8-10 per cent free cash flow yield) and we believe it will achieve future margin growth despite some financing headwinds in the short term. The current business model is attractive given its asset-light nature and the current valuation is undemanding at ~14x price-to-earnings. 

PAST PICKS: August 19, 2022

Celanese (CE NYSE)

• Then: $114.67
• Now: $109.24
• Return: -5%
• Total Return: -3%

WSP Global (WSP TSX)

• Then: $161.62
• Now: $174.05
• Return: 8%
• Total Return: 8%

Park Lawn (PLC TSX)

• Then: $28.82
• Now: $27.96
• Return: -3%
• Total Return: -2%

Total Return Average: 1%