2007 Q1 Newsletter March 31, 2007
Spring has rolled in and with it the end of the first quarter (Q1) of 2007. Just as the weather proved volatile with a delayed start to winter, equity and commodity markets proved volatile as well. Plenty of days in the first quarter registered gains and losses of over 100 points in the Toronto and New York markets. The market moved on the rise and the fall of commodities prices that were somewhat driven by geo political tensions and perceptions of prospects for China. The so-called “Shanghai” surprise triggered a worldwide sell off in financial markets. This overreaction to an 8% drop in the overly speculative Shanghai market after a six day 13% gain. The market gave back half of it’s 13% gain during the previous six day period of what former Federal Chairman Alan Greenspan would have rightly termed “irrational exuberance”. After this brief period of negativity, markets rebounded.
Overall Lawrence Decter Investment Counsel Inc. (LDIC) performance was 2.6% in the first quarter. This exceeded the 2.0% gain on the S&P TSX by 30%. The Dow Jones Industrial Average lost 0.9% for Q1 and the broader S&P 500 gained, but only by 0.2%.
This quarter we have expanded our previous Top Ten Holdings by size to the Top Fifteen Holdings; there are two reasons for making this change. First, the longer list provides a great overview of our holdings. The second is some clients have expressed concern that not all of our top 10 holdings are well represented in their portfolios. In view of timing and differing objectives a number of our top Fifteen Holdings are not appropriate for all accounts.
On average, our top 15 positions experienced a 4.3% gain during the first quarter, eleven were up with a 59.3% gain and four were down lead by Vermillion Energy Trust with a 9.7% decline. Our two largest mining holdings Hudbay Minerals -6.9% and Teck Cominco -8.4% also declined from record highs.
Major Portfolio Changes
We exited three major positions during the first quarter.
Our target on Alliance Atlantis had been $40.00; this represented our assessment of breakup value when we purchased shares from $22.00 to $34.00. Thanks to a takeover bid by CanWest and Goldman Sachs, we were able to exit at $50.00 to $51.00. This represented a good gain from the $34.65 September 9th 2006 close and our cost. We chose not to wait an additional three months when the deal was delayed. Our young but wise trader, Tom Dicker commented that delays are like cockroaches and are rarely found alone. There is now a shareholder lawsuit seeking to block the deal. This could lead to further delays.
Our target on Algoma was $40.00. We had tendered unsuccessfully at $39.00 to a company buy-in offer. We acquired most of our Algoma below $32.00. A rumoured bid drove the price to $53.00 and we chose to exit. Without two bidders it is unlikely that Algoma will be sold above asking price. If current negotiations do not succeed Algoma could see its share price decline towards $40.00 again.
Eveready Income Fund
We wanted to lessen exposure to energy services after in the fourth quarter of 2006 when earnings were missed by a number of comparable companies. Although Eveready is well managed, the downward pressure of their prices will eventually slow their acquisition pace. We exited because of better prospects elsewhere.
We added five new and significant positions during this first quarter of 2007.
With the North American economy slowing and the world economy accelerating we sought companies with much of their business outside Canada. SNC Lavalin is now the 10th largest engineering firm in the world with nearly 90% of its work outside Canada. We believe SNC will benefit by applying its engineering and project management skills on a global basis. Resumption of hydro electric development on the Rupert River in northern Quebec will also benefit SNC Lavalin.
Petrobank is an oil sands development company. Their technology represents an avenue to extract oil from the sands while utilizing far less natural gas and water than other processes. Petrobank boasts large reserves of heavy oil with a very long reserve life. The Petrobank technology allows for extraction of those heavy oil reserves in an environmentally friendlier and cheaper method than the traditional heavy oil production.
Nickel prices have rocketed from US$7.00 a year ago to US$22.00 per pound driven by strong demand for stainless steel from China, escalating costs and delays in new nickel projects (e.g. Goro and Ravensthorpe) as well as, the lack of significant new deposit discoveries. We believe nickel prices will stay in the US$15-16 range over the next two years until new projects come online.
Our favorite nickel producer is FNX Mining. FNX produces and explores for nickel, copper and byproduct precious metals in the Sudbury basin where it acquired five former producing mines from Inco in 2002.
Groupe Laperriere et Verrault
This is a diversified business comprised of three divisions all in process engineering:
The Process Group offers an extensive selection of liquid/solid separation solutions intended for metal and ore processing, as well as industrial and environmental processes used in various other sectors such as power generation, pulp and paper, chemicals, petrochemicals and food processing.
The Water Treatment Group specializes in the development and marketing of equipment for the treatment of municipal and industrial wastewater, drinking water and water used in various industrial processes as well as, water intake screening solutions for certain types of power stations and refineries
The Pulp and Paper Group specializes in the design and marketing of equipment used in various stages of pulp and paper productions, notably pulp preparation and sheet formation and is a recognized leader in rebuilding, upgrading and optimization services for installed equipment
There is a management team in place with a proven history of growth, both organically and via acquisitions. There is a strong order backlog at an all-time high of $571 million as of December 31, 2006.
Reitmans has grown into Canada’s largest women’s specialty retailer with over 900 stores across Canada under seven different banners. The Company has successfully grown its existing banners such as Reitmans and Thyme and expanded into new banners, which include RW & Co. and Cassis. With a strong focus on finding the best, most fashionable product at a specific price point, Reitmans has achieved a five year compounded annual growth in revenue of 13% and earnings of 32%. Reitmans has $241 million in cash to fund future growth and also currently pays a $0.64 dividend. We believe this retailer will continue to grow sales while improving its margins. Furthermore, with the recent acquisition of La Senza, Reitmans would be an attractive acquisition target if there is further consolidation in the Canadian retail industry.
Verenex Energy Inc.
Verenex Energy Inc. is an oil exploration company, 45% is owned by Vermillion Energy Trust; a company with excellent management. Verenex is exploring for oil in both Libya and offshore in French coastal waters. Verenex has drilled one well in Libya that showed 5,000 barrels per day. It is on track to drill several more wells this year. We were impressed with the management team when we met with them.
We are also continuing to search for undervalued smaller companies with excellent growth prospects. To date our efforts have been rewarded in companies such as Axia Net Media, Rally, and Allen Vanguard.
Prospects for the second quarter and the balance of 2007 are mixed. On the positive news front, energy and metals prices are strong, benefiting our overweighting to those investments. On the negative side, a slowing North American growth may depress the overall economy and equity markets. We expect to succeed in the balance of 2007 by being nimble and by adjusting our holdings as conditions dictate.
Michael Decter President and CEO