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Manager Looks for Quality at Deep Discounts

Leith Wheeler says valuations are still deflating, and major challenges have yet to be worked, but for the long-term investor, this environment is your friend.

Brenda Bouw 8 December, 2022 | 1:30AM
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It's a good time to be a long-term, fundamental investor, says David Slater, co-manager of the four-star, gold-rated Leith Wheeler US Small/Mid-Cap Equity Fund.

Equity valuations are depressed after what Slater describes as a "period of extremes" that included years of "artificially low-interest rates" that drove speculative plays such as cryptocurrency, special purpose acquisition companies (SPACs) and meme stocks.

The result is a "radical repricing" of riskier asset classes, he says, and a discounting of more traditional stocks due to rapidly rising interest rates this year and recession fears.

"When looking for discounts as a value investor, periods of uncertainty and disruption play into your favour. We're in one of those periods now," says Slater, who co-manages the $350-million strategy alongside colleague Jeff Daley.

Today’s Challenges Won’t Persist, So Take Advantage Now 

The duo and its team of value investors have been scouring the small- and mid-cap landscape for companies that can withstand the current market volatility.

"We're pretty certain today's challenges aren't going to persist indefinitely and have been able to find some really undervalued stocks," Slater says.

The fund, launched in October 2016, holds about two dozen stocks across sectors such as industrials, consumer discretionary, financials, technology, utilities and real estate.

Slater Buys Undervalued Growth Drivers

Slater says there's also diversity within sectors. He points to the example of two industrial stocks in the fund; Univar Solutions Inc., a global chemical and ingredients distributor, and Booz Allen Hamilton Holding Corp. (BAH), a leading provider of consulting and technology services to the U.S. government.

One of the fund's largest holdings, at about 6%, is Henry Schein Inc. (HSIC), a global distributor of dental and medical supplies.

"There are some growth drivers there that we think have been materially undervalued and a management team that's been highly successful for decades," Slater says.

While it's a U.S.-focused fund, the Leith Wheeler product does hold Canadian-based Brookfield Infrastructure Partners LP (BIP).

"The reason is that there's nothing like it in the United States – and it's a global business," Slater says. "It's best-of-breed business. We also own it in our Canadian portfolios."

According to Morningstar data, the fund was down 4.3% year to date as of Dec. 1, outperforming its category, which was down 10.4% over the same period. The fund has had an annualized return of 8.7% over the past three years, compared to a return of 6.4% in its category. The five-year annualized return was 9.6% versus a return of 6.1% in the category.

How to Find Quality at a Deep Discount?

The fund's benchmark is the Russell 2500, but Slater says its universe stretches to about 2,800 companies with an average market capitalization of about $9 billion. Slater says his team will invest in companies with a market cap as low as around $700 million if it's a more established business poised to scale.

The team's fundamental approach includes researching each company in its market cap universe and talking to management, suppliers, customers and competitors.

"We think like business owners," Slater says. "We look for people who run their companies like true business owners."

And while the philosophy is to find quality stocks at a deep discount, Slater says they will pay a little extra for companies with strong long-term growth prospects. The hunt is for lesser-known companies before they enter the investing spotlight.

"We're trying to find business insights that aren't commonly shared amongst investors and so aren't priced into the stocks we're buying," he says.

Stocks in Focus

Univar is one of those "misunderstood" companies Slater's team likes to purchase for the fund. He says the industrial and specialty chemical distribution company is trading cheaper than its European peers as it undergoes improvements and sees a "major revaluation opportunity" as the company expands and becomes more profitable. 

His team bought the company in March 2020 at around US$13 per share. It currently trades at about US$33. Slater notes Univar recently confirmed that European competitor Brenntag SE had approached it about potentially acquiring the company.

"We've already made a lot of money on Univar and believe there's still a ton on the table," he says. 

His team's most recent purchase is a small-market cable company in the U.S., Cable One Inc. (CABO), a company he's followed for more than a decade when it was part of The Washington Post Company. It was spun out in 2015. The team purchased it in October at about US$730 per share, about a 60% discount from where it was trading at the start of the year.

 "Cable stocks have been derating because there's a threat of new competition from fibre and fixed wireless competitors," he says, but believes the cable industry and Cable One, in particular, are insulated.

He says Cable One is a well-run business with a strong moat. "Yes, there's growing competition, but it'll be very slow to come because of barriers to entry," he says.

Not Everything That’s Cheap is an Opportunity

While there are many good buys in the market, Slater says investors need to be selective.

"We're seeing more opportunities, but they're not the most incredible opportunities that we've seen," he says, citing periods like the turn of the century tech bubble, the 2008-09 global financial crisis and the pandemic-induced sell-off in the spring of 2020 as having deeper discounts.

 "Valuations are still deflating; profit levels for many businesses were excessive, and those aren't fully factored into many companies' valuations. And major challenges have yet to be worked out and resolved. But for the long-term investor, this environment is your friend."

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About Author

Brenda Bouw  Brenda Bouw is a freelance writer and editor based in Vancouver. She has been covering business and investing for more than two decades. She is a former executive producer at BNN and was a business reporter at The National Post, The Canadian Press and The Globe and Mail. She's been a regular contributor to the Globe and Mail's Investor and Advisor sections for the past 10 years. 

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