Summer 2014

Ernest Meissonier ..... caption DEAR FRIENDS... In the 1860s the best selling and most famous artist in the world was the Frenchman Ernest Meissonier.  He painted with meticulous realism and visitors thronged in the hundreds  of thousands to see his latest canvases at the annual Paris Salon held every spring at the Palais des Champs-Élysées.  Patrons such as Napoleon III and James de Rothschild thought nothing of spending the equivalent of tens of millions of dollars in today’s currency for a single Meissionier work.  Critical admirers such as Eugène Delacroix (and no slouch as an artist himself) called Meissonier “the incontestable master of our epoch.”  Delacroix wrote to his poet friend Charles Baudelaire that “amongst all of us, surely it is he who is most likely to survive!” Meanwhile, Edouard Manet, whom we now revere as one of the pioneers of Impressionism, couldn’t beg, borrow or steal his way into the Salon.  His works, such as Déjeuner sur l’herbe and Bar at the Folies Bergère, were considered scandalous and year after year they were spurned by collectors.  Today, of course, it is the other way around.  Meissonier has been largely forgotten and his finer works trade at auction in the tens of thousands of dollars range.  It is Monsieur Manet who now commands prices such as US $33 million for a rare self-portrait sold at Sothebys.                                       ~ Art markets can invert over time and so can a large body of water like Lake Ontario.  The swimming season with the Kingston Mermaids began in late June.  The water temperature, despite the long cold spring and winter, was a very comfortable 21 degrees or so.  For the next ten days those pleasant conditions persisted, and then, as the Mermaids call it, “the lake flipped”.  The warm water that had made swimming so agreeable rolled over and was replaced by glacially cold water that arose from the depths.  The temp dropped about four degrees and it was, to put it politely, daunting! Not to despair though.  As of writing, the lake has flipped again and the temp has rebounded to a more tolerable level.                                               ~ Stock markets too can invert, from hot to cold and vice versa.  We are delighted to note that the Toronto Stock market has led all major markets over the past year and has now more than regained all the ground lost in the ’08/’09 financial crisis.                                        ~ Stay invested, keep swimming and enjoy all that Canada has to offer this summer!  CW CLASS OF 2014 REPORT CARD Outstanding Year Across All Sectors The Headmaster and Editor of this publication is well pleased with the Class of 2014’s average stock return of 21.8% over the July 1/13 to June 30/14 period.  By comparison, the returns of the S&P 500, the TSX and the Dow were 22%, 24.8% and 12.8% respectively over the same period.  The top performer overall was our old friend Vermilion Energy who turned in a sparkling 44.4%.  The worst was another old friend, the grocer Metro, with an underwhelming minus 6.4%.  But the remarkable thing about the Class of 2014 was its consistency.  Every sector, with the exception of real estate turned in healthy gains. In hindsight, it is always easy to provide explanations for success (or failure).  The U.S. economy continued to recover nicely, the Fed cooperated with continuing low rates, Europe didn’t implode, and so forth.   However, as the Headmaster points out, those are all factors over which he had no control.   As he is wont to say, 90 per cent of success in investing has to do with what we can control; e.g., picking the stocks of companies with sustainable advantages, at reasonable prices, and sticking with them.  If those stocks pay a dividend and their boards have a habit of increasing them, even better.  Here are the sector by sector reports.  Resources – A What can we say?  The energy group – not for the first time – comprising class stalwarts Vermilion, Crescent Point and Enbridge, led the way with average gains of just over 30%.  All promoted.  Agrium, the fertilizer and farm supplies conglomerate continued to bear out the wisdom of our long term agriculture thesis with a respectable 7.2% performance.  Promoted.  Trailing the resources pack was forlorn Teck Resources, the Vancouver-based miner.  Teck eked out a return of 3% to March ’14 when the Headmaster said it would regrettably have to seek another learning institution.   While Teck’s valuation is attractive (nay, cheap), there are too many uncontrollable factors governing its turnaround. To replace Teck, the Headmaster has called upon the global methanol producer, Methanex.  This Canadian company uses natural gas to produce the all-purpose industrial agent, methanol (otherwise known as wood alcohol).  Its strategic advantage, apart from scale, is the enduring low price of natural gas (used for feedstock) in North America.  Financials – A When it comes to class members Bank of Nova Scotia, Royal Bank and TD Bank, there is no way of getting around the obvious: oligopoly pays.  How much you may ask?  In the case of these three: an average of 26.8% over the past year.  Long may the oligopoly continue!  Promoted!  The other member of this sector, Power Financial (PWF) of Montreal, turned in a respectable year over year performance of 8.6%.  Sadly, however, that was not enough to impress the Headmaster.  As much as he admires the canny Demarais family that controls PWF, he has decided to ask this original class member to leave.  His chief argument is that PWF is losing the mutual fund wars to the banks.  Profit margins have been steadily shrinking and assets under management growing at a feeble rate.  In consequence, the company has yet to increase its dividend five years on after the financial crisis.  By comparison, each of our banks has boosted its payout numerous times over the same interval.      Retail – B Consumer staples are not sexy, but in the Headmaster’s view, they have a defensive role in most portfolios.  In that context, the 11.1% average return of Metro, Walmart and Alimentation Couche Tard was more than adequate.  The Headmaster was particularly pleased with last summer’s class addition, Couche Tard.  The convenience store and filling station chain racked up a nifty 38.6% gain.  Couche Tard has been in a resting phase, paying down debt and consolidating its big expansion into Europe.  He expects more acquisitions and forward momentum from this classic growth stock in the coming year or two.  Promoted.  As the U.S. economy continues to gather steam,  albeit slowly, the Headmaster is less convinced of the argument for keeping both Walmart and Metro in the Class of 2015.  Both have decent prospects but face serious competitive challenges in their respective spheres.  On balance, the Headmaster has concluded that Metro is the more nimble of the two and better positioned for continued growth and returns to shareholders.  Metro, promoted.  Walmart, farewell.  Infrastructure – A Brookfield Asset Management was replaced by its little brother Brookfield Infrastructure Partnership (BIP.UN) in March.  While big brother is an excellent company, the Headmaster wanted the clearer focus on infrastructure and the healthy dividend (currently 4.7%) of BIP.UN.  Between the two of them, these stocks returned 20.6 % over the class year.  Promoted.  Industrials – A+ A year ago the Headmaster described Russel Metals, CNR, John Deere and Phillips 66 as “strategically positioned to take advantage of their individual strengths, as well as continued healing in the economy”.  They more than rewarded his confidence with an average return of 31.9%.  All are promoted with the exception of Phillips 66, the oil refiner and chemicals conglomerate that has benefited from discounted North American energy (vs. international ‘Brent’ benchmarked energy).  The company performed brilliantly over the past year – near the top of the class with a 36.5% return, but the Headmaster now sees a company like Methanex as a purer energy arbitrage opportunity.  Healthcare – A Johnson & Johnson is the epitome of a blue chip stock. It has a triple ‘A’ credit rating.  It has increased its dividend without fail 52 years in a row.  Its stock price has enjoyed compounded annual growth in the double digits for decades.  Last year was no exception, as J&J produced an annual return of 21.8 %.  The stock is now richly valued, but the Headmaster is undeterred.  He sees years of growth ahead for this steady performer.  Promoted.    Telecom – A Our telecom duo, BCE and Telus, were under a cloud at this time last year.  Investors were waiting for a decision from the American telecom giant, Verizon, on whether it would respond to the government’s blandishments to enter the Canadian marketplace.  The Headmaster decided to “hold his breath and wait for further developments”.  In hindsight that was a good decision.  Verizon folded its tent and went home and our incumbent pair responded accordingly.  Over the class year BCE and Telus stock prices appreciated by 12.2 and 29.5% respectively.  Once again, the federal government is making noises about encouraging the creation of a fourth national carrier (Rogers being the third incumbent).  The Headmaster is sceptical and expects the incumbents to continue to enjoy – as the banks do – their oligopolistic advantages.  Promoted.     Real Estate – C minus RioCan REIT, the shopping mall operator, was asked to leave the class last December after logging and end of term loss of -1.8%.  The Headmaster’s decision was largely predicated on interest rate risk.  While rising rates have not materialized yet, the risk for interest rate sensitive stocks like RioCan has not gone away.    Information Technology – B Visa was welcomed into the class last December.  Contrary to popular impressions, Visa (like its main competitor, MasterCard) is not in the business of extending credit to credit card holders and making profit from the interest on the unpaid balances.   Visa licenses its brand, and the payments technology that underlies it, to financial institutions and businesses around the world.  The end users are the ones to point your finger at if you are worked up about usurious credit card interest rates.  In return for making its ubiquitous payment infrastructure available, Visa extracts a thin but meaningful slice from every transaction using its systems.  Whether credit or debit, this happens millions of times a day, 365 days a year.      The Headmaster is quite content with Visa’s 4.6% gain since joining the class, and sees high double digits growth, stock buybacks and dividend increases from this highly sustainable business for years to come.  Promoted.  [If you would like further information on any of the investing ideas raised in this issue, or a complimentary consultation, please call or email.  CW]