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Expert Insights Shares Small Cap

Canopy Offers Attractive Investment Exposure to the U.S

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Although we expect the medical market to shrink as consumers turn to the recreational market, we forecast more than 10% average annual growth for the entire Canadian market through 2030, driven by the conversion of black-market consumers into the legal market and new cannabis consumers.

Canopy also exports medical cannabis globally. The global market looks lucrative, given higher prices and growing acceptance of cannabis’ medical benefits. Exporters must pass strict regulations to enter markets, protecting early entrants like Canopy. Partially offsetting the global markets’ potential for Canadian producers are threats of future production from countries with cheaper labor— the single largest cost. However, many Canadian companies have pulled back expansion plans given ongoing cash burn. We forecast around 15% average annual growth through 2030.

Besides hemp, Canadian companies typically have no U.S. operations, given legal limitations. However, Canopy has a standing deal to acquire Acreage Holdings, a U.S. multistate operator, immediately upon federal legalization. We thought Canopy paid a good price and acquired an attractive option for an accelerated entry into the U.S. Canopy also owns 27% of U.S. multistate operator Terrascend on a fully diluted basis. The U.S. market is murky, with some states legalizing recreational or medical cannabis while it remains illegal federally. We expect that federal law will be changed to recognize states’ choices on legality within their borders. Based on our state-by-state analysis, we forecast nearly 20% average annual growth for the U.S. recreational market and nearly 10% for the medical market through 2030.

Constellation Brands owns 38.6% of Canopy with additional securities that could push ownership to 55.8%. We see the investment as supportive of developing branded cannabis consumer products while also providing a funding backstop and foothold into the U.S. non-THC market.

Company Profile

Canopy Growth, headquartered in Smiths Falls, Canada, cultivates and sells medicinal and recreational cannabis, and hemp, through a portfolio of brands that include Tweed, Spectrum Therapeutics, and CraftGrow. Although it primarily operates in Canada, Canopy has distribution and production licenses in more than a dozen countries to drive expansion in global medical cannabis and also holds an option to acquire Acreage Holdings upon U.S. federal cannabis legalization.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.               

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Global stocks

CCRE Expansion Key for Future Growth

While the spin-off reshapes CCRE into more defined focus in property development, the asset-light business—which enjoys higher price-to-earnings multiples–is carved out of CCRE, which may dampen investor optimism on the post spin- off CCRE. We resume coverage of CCRE post spin-off and revise our fair value estimate to HKD 2.92 per share from HKD 4.40 per share. The shares are undervalued, trading at a depressed price/earnings ratio of about 2.2 times 2021 earnings. In our view, this is attributed to the spin-off mode not improving the balance sheet and the slower-than-peers contracted sales recovery. Moving forward much will depend on how the company’s recently articulated Greater Central China Strategy will pan out to improve growth prospects.

Contracted sales shrank 4.8% year on year to CNY 68.3 billion in 2020, which fell short of the company’s CNY 80 billion target and performance is largely below that of peers. We note that the company attributed the underperformance to a slower pace of saleable resources launched and reiterated its confidence in the Henan market. Nonetheless, CCRE recently articulated its Greater Central China Strategy to cover a large market radius around its Zhengzhou home base to bolster growth. However, we think the geographical expansion strategy may take time to bear fruit as the company enters new markets. For the first four months of 2021, the run rate looks off the pace with contracted sales at 17% of full year target. Hence, we think for this year the CNY 80 billion contracted sales target the company retained from last year looks aggressive, which may dampen share price performance.

Company Profile

Central China Real Estate is a China property developer founded by Chairman Wu Po Sum in 1992 and listed on the Hong Kong Stock Exchange in 2008. Differentiated from most other listed Chinese developers with a nationwide presence, CCRE is focused primarily in Henan province. The company’s coverage is spread across Henan’s prefecture and county-level cities, as well as a small presence in Hainan. Zhengzhou is a key market for the company, contributing the highest contracted sales and salable inventory among cities in Henan. The company has spun off its asset-light project management business and seeks geographical expansion via its Greater Central China Strategy for growth. Wu owns the controlling stake of about 74.9% in CCRE.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.               

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Commodities Trading Ideas & Charts

Con Ed four natural gas storage facilities with a combined Capacity

The principal asset of the joint venture is three natural gas pipelines with a total capacity of 3 billion cubic feet per day and four natural gas storage facilities with a combined capacity of 41 Bcf. The pipelines and storage facilities are all located in New York and Pennsylvania. The sale of the joint venture for $1.225 billion was in line with our estimate and has no impact on our fair value estimate or EPS estimates. We had already assumed Con Ed would divest its gas transmission investments, following comments in the 2020 10-K that it was considering strategic alternatives for its interest in Stagecoach. Stagecoach is the primary operating asset for the Con Edison Transmission segment, or CET, contributing $0.17 per share in 2020, or about 4% of consolidated EPS.

In March, we reduced our EPS estimates from 2021-2024 by $0.04 to $0.06 per share due in large part to the dilutive impact of our assumption that Con Ed would exit the gas transmission business. At that time, we also established a 2025 EPS estimate of $5.00, resulting in a 4.1% average annual EPS growth rate near the bottom of ConEd’s EPS growth target of 4%-6%. CET also has a projected 8.5% ownership interest in the proposed 300-mile Mountain Valley Pipeline. In 2019, exercised its option under the MVP joint venture agreement to cap its cash contributions at $530 million. In May, MVP announced a six-month delay in the projected startup and an increase in the estimated cost to $6.2 billion from the previous estimate of $5.8 billion to $6.0 billion.

We remain concerned the MVP will never be completed due in large part to the ongoing delays and increasing uncertainty with respect to obtaining necessary permits for waterbody and wetland crossings because of ongoing court challenges. Dominion Energy and Duke Energy elected to abandon The Atlantic Coast Pipeline, a project also moving Appalachian shale gas to Virginia and North Carolina, last year after running into similar challenges.

Company Profile

Con Ed is a holding company for Consolidated Edison Company of New York, or CECONY, and Orange & Rockland, or O&R. These utilities provide steam, natural gas, and electricity to customers in south eastern New York–including New York City–and small parts of New Jersey. The two utilities generate roughly 90% of Con Ed’s earnings. The other 10% of earnings comes from investments in renewable energy projects and gas and electric transmission. These investments have resulted in Con Ed becoming the second-largest owner of utility-scale PV solar capacity in the U.S.       

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.               

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Funds Funds

Devon Alpha Fund

This is the fourth portfolio manager change on this strategy in four years. In early

2019, Devon announced it was changing the portfolio manager to Mark Brown from Nick Dravitzki. Prior to taking the portfolio manager role, Brown had been the chief investment officer at Devon. Dravitzki had been the portfolio manager on this strategy since 2017 following previous portfolio manager Robertson’s ascension to the key business management role. This level of portfolio manager change on a strategy that allows significant flexibility for the key decision-maker rarely leads to good outcomes in the short to medium term, even with an experienced team.

The investment process seeks to identify companies in the NZX 50 and S&P/ASX 200 indexes that have the ability to generate strong returns on invested capital and achieve good cash flow expansion or have unappreciated catalysts for revaluation. The strategy allows for a portfolio of just 10-15 stocks, so the fund carries significant stock- and sector-specific risk, which may result in greater volatility than more-traditional strategies. In addition, the portfolio manager has a high level of discretion and can allocate 0-100% to New Zealand stocks, 0-100% to Australian stocks, or 0-100% to cash. Historically, cash levels have often been in the 20%-30% range but have been lower since mid-2020. The portfolio manager also has the flexibility to short-sell stocks (though we’ve rarely seen it used) and invests outside Australasia.

Since inception, the strategy’s returns have been largely lacklustre, which is not entirely unexpected given the difficulty in getting cash levels right and the portfolio manager changes.

Devon Alpha has some interesting characteristics, but the numerous portfolio manager changes constrain our enthusiasm.

Devon seeks to identify Australasian companies with the ability to produce strong returns on invested capital. Devon generates investment ideas through its fundamental research process and draws on its members’ extensive experience. On-the-ground research is an important part of the process; the team will not only visit management of companies in the portfolio and potential holdings, but also competitors, suppliers, and customers. Discounted cash flow is the most important factor in the valuation decision, ensuring the team avoids overpaying for companies. The investment decision also considers the strength of the business model, the relative attractiveness of the industry, quality of management, and the company’s financial health. These factors are assigned weightings that the portfolio manager uses in his portfolio construction process.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

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Funds Funds

Devon Dividend Yield Fund

However, Nick Dravitzki, who had been portfolio manager on this strategy since it was launched in 2012, resigned in early June 2020. Devon’s experienced chief investment officer, Mark Brown is now portfolio manager here. He is assisted by the investment team, which includes managing director Slade Robertson, three portfolio managers, and two senior equities analysts.

The investment team is tight-knit and possesses valuable experience, but in recent years the good quality research and portfolio construction we had come to expect from Devon has marginally declined relative to peers. In addition, a change of portfolio manager, in the short term, can be unsettling for an investment team and strategy. However, Robertson has restructured and reinvigorated the team by hiring two additional analysts and increasing his mentoring of the investment committee. The investment process is straightforward, with an emphasis on fundamental bottom up research. The team invests in companies based on their gross yield to a New Zealand investor and the sustainability of that yield. The 20-25 stock portfolios is high-conviction and therefore carries significant stock- and sector-specific risk, which may result in greater volatility than peers.

Utilities, listed property, and financial services companies typically take up 45%-50% of FUM.

However, there are no restrictions on the amount invested in Australian and New Zealand companies, providing the portfolio manager with significant flexibility to allocate capital where he sees opportunities. Since inception, the strategy has experienced mixed performance. The process worked well up until late 2016, but since early 2017 the strategy has struggled against the index and equity region Australasia Morningstar Category peers. The process behind Devon Equity Income is reasonable, but our conviction is stronger with peers at this time.

Devon Dividend Yield aims to provide investors with a stream of income by constructing a concentrated portfolio of New Zealand and Australian companies, with a 2% blended yield improvement compared with the market. Devon screens the S&P/NZX 50 and S&P/ASX 200 indexes and ranks stocks by their gross dividend yields to a New Zealand investor. Valuation of top-ranked stocks is determined using a discounted cash flow methodology. Devon will go the extra mile to obtain an understanding of the intrinsic value of a business. Fortunately, a healthy travel budget accommodates this, whether for company visitation or investment conferences.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.               

Categories
Funds Funds

Devon Trans-Tasman Fund

Willis and Robertson are supported by the Devon investment team of Chris Glaskin (portfolio manager), Mark Brown (portfolio manager/ chief investment officer), Victoria Harris (sustainability portfolio manager), and two investment analysts. The investment team is tight-knit and possesses valuable experience and knowledge. In addition, Willis undertakes considerable company visits and management meetings in New Zealand and Australia. However, during the past few years, there have been some missteps in stock selection and portfolio construction that have prevented the fund from outperforming its index and peers. Issues have included limited exposure to some of the largest and best-performing New Zealand stocks. We believe the good quality research and portfolio construction we had come to expect from Devon had declined relative to peers. However, during 2020, the highly experienced Slade Robertson restructured and reinvigorated the team by hiring a sustainability portfolio manager and two additional analysts; he also became co-portfolio manager of this strategy. Robertson had been portfolio manager of the fund up until 2015.

The process is straightforward and repeatable, with an emphasis on fundamental bottom-up research. The team searches for companies with sustainable earnings, high return on capital, good cash conversion, and low capital expenditure. A benchmark-agnostic high-conviction approach is adopted when constructing the growth-orientated portfolio of 25-35 stocks, which often contains mid- to small-cap companies. Despite recent solid performance, on a trailing returns basis, the strategy has fallen behind equity region Australasia Morningstar Category peers the category index (50% S&P/NZX 50 Index and 50% S&P/ASX 200 Index) over the trailing three and five years to 30 April 2021.

Devon seeks to identify Australasian companies with the ability to produce strong returns on invested capital. Devon generates investment ideas through its fundamental research process and draws on its team members’ extensive experience. The team travels extensively to obtain an understanding of businesses and to determine the intrinsic value of companies. A healthy travel budget accommodates this, whether it is for company visitation, investment conferences, or idea generation.

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.