It was a dramatic difference from how this quarter began versus last year. Recall, in January of 2016 the TSX was down 6.73% compared to this year finishing up 0.85% as the markets continued to rally in part by Trump’s proposed policy changes. We are pleased how the Fund performed versus its benchmarks. For the quarter the Long/Short Fund posted a solid +5.52% return handily beating the S&P/TSX (+2.41%) and the TSX Small Cap Index (+1.47%). Outperformance for the Fund was primarily driven by our Technology, Consumer Non-Cyclical, and Industrial weightings which we will discuss more in detail further.
Below is an analysis of the Fund and some comparative indices in Q1:
|Q1 2017||YTD 2017||Since Inception|
|Jemekk Long/Short Fund||5.52%||5.52%||184.44%|
|S&P/TSX Small Cap Ind.||1.47%||1.47%||66.00%|
*Benchmarks quoted in Total Returns
The markets continued to show strength in Q1 picking up where Q4 ended. The TSX was positive for each month in the quarter led by gains from the Technology, Materials, and Consumer Discretionary sectors and the underperformance for the index was almost entirely from the Energy side. WTI was down nearly 6% for the quarter caused by a combination of negative build numbers, further uncertainty of OPEC production plans and increasing crude inventories in the US. The Small Cap Index continues to underperform as investors bid up more liquid and established companies.
From a macroeconomic standpoint, we agree there is a lot to be worried about. For instance, the US markets are hitting new all-time highs and we are in year 8 of a bull market and market experts are the first to point out the average bull market lasts on average 9 years. The PE ratio for the S&P 500 is above its average range suggesting the market is overvalued. The Fed announced its first rate hike of the year (we are expecting two more) which directionally is negative for equities. Shifting to political factors, the agenda for the Trump administration remains uncertain. There are pockets of the market that will be affected materially if some of Trump’s polices come to fruition. One example is the ‘Border Tax Adjustment’, that will significantly hinder companies that rely heavily on importing. But not all of Trump’s polices read negative. One such policy is to reduce corporate taxes which will result is a massive windfall for American companies. However, now execution is in question given the recent failure of the healthcare repeal from the Trump administration.
The Fund started the year at 92% net long and stayed as such exiting the quarter at 95% net long. This number will be taken down as we layer on new hedges that were rolled off at quarter end. You might be asking why are we at the high end of our historical range for exposure given the negative backdrop highlighted above? Well, not all is negative in the markets and definitely not all sectors. There have definitely been some recent policy setbacks but we believe tax reform and deregulation are in the works which will benefit select areas of the market. Overall, we are still constructive on the market as earnings have improved and both the M&A and IPO space remain active. We also believe there is a paradigm shift occurring in the market from passive to active management and we are working diligently to unearth great opportunities. Events in the quarter that led to the outperformance are as follows: we had two stocks that got taken out (RDM Corp. and Halogen Software Inc.); we had gains from a breadth of sectors namely Technology (Shopify), Consumer Non-Cyclical (GreenSpace Brands), Industrials (New Flyer Industries), and Precious Metals (Junior Gold stocks). Energy on the other hand was a drag on the Fund with losses from names such as Spartan Energy and Seven Generations. Below we highlight a new name for the Fund:
Cargojet Inc. (CJT) – A new addition to the Fund this year, Cargojet is the dominant provider of overnight air cargo in Canada but also provides services globally. With a fleet of 21 aircrafts, Cargojet operates in three segments: (1) Core Domestic Overnight (~83% revenues); (2) Aircraft, Crew, Maintenance and Insurance (~12% revenues); and (3) Charter (~5% revenues). Following we lay out our investment thesis:
- Strong Free Cash Flow Generator – Cargojet’s capital expenditures stepped up materially upon winning the Canada Post Contract including start-up costs launching the transformational initiative (CPC was a game changer deal won in 2017 by CJT with an estimated value of $1b over 7 years). With these one time costs behind them, mgmt. can now focus on overall company optimization and see FCF improving significantly in the near term. Specifically, we expect mgmt. to prioritize its FCF towards dividend growth as the current yield is only 1.65% (on March 20th the company surprised the street by increasing the dividend by 10% another signal of the strength in FCF) and de-levering. The company currently has a FCF yield of approximately 11%.
- Barriers to Entry – Cargojet is one of the rare companies we have come across with a natural monopoly commanding a 90% market share in domestic overnight cargo. Canada’s unique geography being vast and sparse has created an opportunity for CJT and the company as such moved quick and has established first mover advantage. We believe the competitive moat for CJT runs deep given its customer base, network advantage, and large fleet size. CJT holds key contracts such as UPS, CPC, and TransForce – it would be next to impossible for a competitor to replicate their model. CJT also services its customers extremely well, to date, CJT has never lost a contract.
- E-Commerce Tailwind – Cargojet is also experiencing an uptick in business from the proliferation of online shopping. E-commerce is still only 10% of total US retail and this figure is lower on a global basis however these numbers are expected to grow as we are witnessing a secular shift to online shopping which bodes well for CJT. Canada Post states that “Eight out of 10 Canadians shop online and they’re buying more items more often each year. Canada Post delivers two of every three parcels they order.” The ‘Amazon Effect’ is no secret and without argument disrupting brick and mortar. Cargojet stands to benefit two ways: (1) CJT is the primary cargo provider for all the majors such as UPS, Purolator, and FedEx; and (2) Amazon has an exclusive agreement with CJT making AMZN one of CJT’s top 10 customers.
We look forward to seeing this small-cap company continue to expand into new geographies as well as consolidating its current markets. This industry is still growing and after a recent meeting with mgmt. we learned capacity and asset utilization has ample room to foster this growth.
As we enter the second quarter of the year we are mindful of the material risks in the market (namely on the political front) but we also see key economic indicators signaling further strength in the economy. Consumer spending increasing and overall consumption ticking higher. Consumer confidence remains high and we are fast approaching earnings season which we are optimistic on. One thing we found interesting was the market continued to rally into the new year despite weak performance of the ‘Trump Stocks’, those benefitting most from the proposed tax reform and ‘America First’ agenda. This confirms our belief that active management is as important as ever and we as stewards of your capital are tasked with finding the best opportunities to capture alpha.
We would like to take this opportunity to share some corporate developments with you since our re-org last year. We are pleased to add new members Peter O’Connell, Scott MacNicol and Chris Hercus to our team. Peter joins us from the sell side of the street in various roles with 20+ years in the investment industry building relationships with institutional and retail clients. As Managing Director Pete will be running sales for us and should significantly improve our ability to service our partners. Scott joined the team in early 2017 as a Senior Advisor to the group bringing with him decades of sell side experience, most recently as Head Trader at TD Bank following their acquisition of Newcrest Capital. And finally, Chris joins us as a Trading Associate from Front Street Capital and will significantly help us scale, both from a trading perspective and as importantly, in operations.
Lastly, we would like to share with you our decision to return to our roots by rebranding as Jemekk Capital Management again. Our partners know us as Jemekk, our Funds continued to be called Jemekk and our history as Jemekk that spans back to 2004 is something we want to embrace. Although this will take little effort from your perspective it is something we are anxious to get moving on to minimize any brand confusion created by adopting the J2 moniker. Look for further updates from us with respect to this fairly seamless change.