Tag: Commentary

2024 Year End Update

Overview

As a journal for my thoughts and actions on investing, I’ve decided to record quarterly investment activities that don’t merit separate posts. I plan to write these reviews semi-annually, which aligns with my philosophy that investment actions, including updates, should be driven by necessity rather than calendar obligations.

Given that it is a new year, I also comment on portfolio performance in 2024.

Q4 2024 Portfolio Activity

Getting My Tech Off – Strategic Portfolio Exits in ENGH and OTEX

Two significant positions were closed during the quarter as part of my evolving investment strategy. Enghouse Systems (ENGH) and Open Text Corporation (OTEX) were divested, with proceeds redeployed to strengthen existing positions in Brookfield Corporation (BN), Brookfield Asset Management (BAM), and Toromont Industries (TIH).

Enghouse Systems, despite its strong financial metrics including high return on invested capital and debt-free balance sheet, faced increasing competitive pressures in its contact center business from behemoth Microsoft (MSFT). While the company has successfully transitioned toward software-as-a-service revenue models, its growth remains heavily dependent on acquisitions. The emerging threat from artificial intelligence in the contact center space, combined with significant key person risk in founder-CEO Sadler, led to my exit decision.

The Open Text position, initiated during a period of dividend-focused investing, no longer aligned with my current investment criteria emphasizing deep business understanding and sustainable competitive advantages. Frankly, I didn’t even pay attention to the company beyond a cursory examination of cash flow and dividends.

This is a practical lesson in being confident in one’s own process, or to invert that: to not blindly follow others. Of course it is fine to adjust what we do, and how we do it over time. Indeed, one should; the world is not static and we learn from experience. Chasing what others are doing because one doesn’t know what their approach is, however, is not a good recipe. Much like sailing without a rudder, one is subject to the vagaries of the blowing wind.

Healthcare Sector Repositioning

A strategic rotation within healthcare saw me exit Johnson & Johnson (JNJ), held since 2015, in favor of Thermo Fisher Scientific (TMO). While the long-term thesis on healthcare demand growth remains intact, TMO offers superior exposure to this trend through its “picks and shovels” business model, serving both healthcare and adjacent markets. This decision followed extensive analysis of TMO’s market position and growth prospects, which will be detailed in a forthcoming post.

Performance Review

Whilst acknowledging the limitations of calendar-year performance measurement, the portfolio generated the following returns in 2024:

Unregistered Accounts: 12% to 24%

Registered Accounts: 19% to 36% (with one account at 2% due to underperforming REIT exposure)

These results compare favorably to major indices:

  • Toronto Stock Exchange (TSX): 18%
  • NASDAQ: 29%
  • S&P 500: 23%
  • Dow Jones Industrial Average (DJIA): 13%

Given that I have a mix of stocks across all these, few tech stocks, a broad comparison feels relevant. Performance is particularly noteworthy given limited exposure to technology stocks and complete absence of the “Magnificent Seven” companies that drove significant index returns.

Investment Philosophy Evolution

My investment approach has evolved meaningfully from its dividend-focused origins. This evolution began after studying various dividend-focused strategies, including those emphasizing tax-advantaged eligible dividends in Canada. While such approaches can and have indeed succeeded, I’ve concluded that they might sacrifice substantial capital appreciation potential and create unnecessary complexity through over-diversification. This reflection led to a significant refinement of my investment approach.

My current strategy targets a 9% compound annual growth rate, focusing on high-quality businesses I can hold for extended periods. This target would double invested capital every eight years. Dividend income, while welcome, is no longer my primary consideration.

Thus, having moving away from both pure dividend targeting and “cigar butt” value investing, I am instead emphasizing:

  • Companies with sustainable competitive advantages
  • Businesses I deeply understand
  • Opportunities for long-term value creation
  • Management teams with strong capital allocation skills

Looking Forward

The portfolio’s strong performance in 2024 seems to validate my refined investment approach, but I recognize it is only a single year. More importantly, a clearer investment philosophy and improved analytical framework should better position me for future opportunities. I think I’ll maintain semi-annual communication cadence, supplemented by specific investment analyses when warranted.

Good luck to all and enjoy the ride!

CIBC – Can I Buy (more) Cheaply?

Introduction

CIBC’s journey from Wall Street wannabe to steady Canadian banking powerhouse is a tale of redemption—and right now, it’s a story of success trading at a premium price. After climbing out of some of the most spectacular financial mishaps in Canadian banking history, the bank has transformed itself. But does its current stock price reflect potential or overvaluation?

It’s been one hell of a good year for CIBC shareholders. As with all Canadian banks, their fiscal year end is October 31*, and results for Q4 and full year 2024 were reported on December 5. This one is one of my biggest positions, from my time when I was particularly focused on dividends. It’s been a good year, and purchases made during the Pandemic period have also panned out quite nicely – see this 5 year stock chart:

Before diving into this year’s results, a brief recap of their history.

Let me see your bulge…bracket

They are Canada’s 5th largest bank by assets and most domestically weighted of the ‘big 5’ notable for its very large residential mortgage portfolio. This wasn’t always the case.

They’ve come a long way since the heady days of the late 1990s and early 2000s, when then-management tried to make it a US Bulge Bracket Bank, competing with the Wall Street firms (i.e. Goldman Sachs, Morgan Stanley, JP Morgan). CIBC was involved in tech IPOs, private equity and arguably tried to be too many things to too many people. There were offices across Europe; they owned investment bank Oppenheimer; executives made the news for buying expensive real estate; CEO succession was fraught and made front page news.

Then the tech bubble popped; the bank was one of many involved in Enron and had one of the largest fines for its role (which still haunted the bank through 2019, having fought with tax authorities about how much of the expense could be deducted against income); the great financial crisis hit, and out went the share price with over $9B in subprime write downs. Leading into that CEO Gerry McCaughey had been appointed around 2005 to stabilize the good ship CIBC, and by 2008-09 many current senior executives had joined at that time from outside the bank, including Merrill Lynch, National Bank, and elsewhere.

As a result of a decade of knocks through 2010, the bank retreated to the foundation that was its Canadian business. Oppenheimer was sold; foreign offices closed or scaled back; and new business was kept to fairly vanilla banking activity. The stock was arguably overlooked by the investing community, and with good reason, having gained a reputation as the bank most likely to step onto a sharp object. That and CEO McCaughey was tasked with keeping things stable, not grow!

This meant the stock traded with a below market PE ratio. See the blue line in the chart below:

Stock Unlock: Free Form Tool, comparing the Big 5 Canadian banks’ PE in the past 10 years.

How does a company work out of a situation like this? Ideally, change the culture and prove it to investors with steadily improving results.

Show me the money!

With McCaughey retiring in 2014 – and how it came about was somewhat emblematic of old CIBC, having renewed his employment contract for three years and then deciding to depart, resulting in a very large payout – succession was brought back to the fore and there were concerns in some corners that the market would see a succession battle like times of old. Somewhat surprisingly, it didn’t happen. Victor Dodig, then head of wealth was appointed by the Board after a search.

In fairly short order, he completed a big round of musical chairs in senior executive ranks. Why? He wanted to ensure that the bank did not find itself in the situation it did when he was appointed. Specifically, he wanted to make sure that there was a “deep bench” of talent that were experts in more areas than a single business line they may have come through. Over his 10 year tenure, this shuffle in the ranks every few years continues, and it seems like results in the business are paying off.

But that skips over the rumbling that started growing a few years into Dodig’s time as CEO. He wasn’t really doing anything. What would be his legacy? What’s the bank’s story? What is CIBC, other than merely Canadian bank? It had been nearly a decade without much to speak of except the problems were past. The other banks can quickly be described – TD and BMO are very American (in different regions); RBC has global aspirations; Scotia is very big in South America.

So what’s a CEO to do? Buy something!

The Purchase of the (21st) century

 In 2017, CIBC completed its record setting purchase of US bank the PrivateBank, based in Chicago. It was known for its customer focused, relationship centric lending practice in the US midwest. The purchase was initially panned after CIBC chased its prize, increasing the purchase price by 20%, in the face of reforms from then-President Trump that resulted in bank asset prices rising.

It was a bold move, that quickly started to pay off, by diversifying the bank, giving it a footprint in the US again outside of capital markets activities and a source of business deposits. Since the acquisition, the bank increased earnings from the US from about 5% at the time of the purchase to over 20% this past fiscal year.

Back to the future! Oh, and Fiscal 2024.

With that brief trip through time, we come back to results this past fiscal year. Handily, their investor fact sheet does the talking quite nicely, so no fancy Stock Unlock charts for this section.

Growth in most metrics have been on a steady uptrend since the 2020 Pandemic year, with some fluctuations owing to losses, particularly in the commercial office portfolio and a ~$1B provision to settle a lawsuit filed by Cerberus in 2015, which hit 2023 results (article). ROE, the common measure of returns for banks, is on an uptrend again after last year, and capital levels are well above OSFI regulated minimums.

Ironically, the Cerberus settlement plus the US regional banking crisis plus US commercial real estate concerns meant market expectations at the end of Fiscal 2023 – a year ago – were pretty low, with some worried it might signal a return to the bank of old and thus didn’t believe the emerging track record of steady results.

In other words, and perhaps with a little benefit of hindsight, the market had over-punished the stock, so with steady and quite positive results in 2024, the potential returns were quite high and indeed, the share price whiplashed back around again. Total shareholder returns were almost 100% in the past year, which for a Canadian bank is absolutely ridiculous.

With the ship righted, a course charted, and engines on full steam ahead, and my nautical references exhausted, the bank has some exciting times ahead of it:

Valuation

This brings us to the question of whether it’s trading at a fair price right now. As usual, I used Stock Unlock to complete my valuation. I used P/E as the valuation metric (10.5 5yr avg), assumed EPS growth on the low end of guidance (7%), and dividend growth slightly below this (5%) as I feel the next two years may pose a challenge to the bank with a significant amount of mortgages up for renewal so management may want to preserve some earnings to build capital to buffer against any losses. I also assume they don’t use their authorized share buyback and so stick with ~1% p.a. average share issuance.

Taken together, the FV is about $73/sh or almost 5% CAGR.

Increasing growth to the high end of 10% gets us to $82/sh or almost 7% CAGR.

If they can keep that growth, I think it’s more likely they would maintain their premium (to their average) PE. Right now the PE is over 13, but I use 12, resulting in a FV of $91.50 and just over 9% CAGR.

Seems like that’s what the market is pricing in, but for me it’s rich at current prices. I like the story, I like the direction, and I like the dividends (up another ~8% this year – a nice raise!), but I’m not going to add to this position right now.

*Perhaps apocryphal, but apparently the banks agreed to do this to help accountants who were otherwise busy from January-April with those whose fiscal year ends matched the calendar (link: https://archive.is/EI4k7)

BCE – Bloated Corporate Enterprise

Overview

With some interest in dividend circles over BCE’s seemingly juicy dividend yield of 8.2% (as of Sep 5/24), I decided to review my thoughts nearly a year on from selling this former core part of my portfolio. I first bought BCE in January 2015 for $53. I sold it in November 2023, almost 9 years later for…drum roll, please…$53.85. Including dividends, my CAGR was a measly 2.7%. According to the Bank of Canada, inflation also averaged 2.7% over this period, so I earned 0% in real terms. So much for safe.

Setting the Context

BCE has long been a favourite for income investors, with a steady yield and growing dividend. It’s why I originally bought it, when I was looking for good, safe, dividends. Which it certainly paid out, but really only ever done that:

Stock Unlock dividends snapshot for BCE, showing growth and yield for the 10 years through Sep'24.

Stock Unlock: Dividends for BCE 2014-2024/09/04 (pulled Sep’24)

BCE did provide a stable yield, but this came with very low price growth (<5% CAGR) and frankly sub-par returns. I recognize that I say this with the benefit of hindsight. With my value lens now, would I have done differently? I wish I could say I would have sold around $70, but I really don’t know.

Peering into the Behemoth that is BCE

It was an exciting time in the late 2010s. Operations were generating ROIC around 15%, wireless subscriber count was rising, Samsung and Apple constantly rolled out phones, FCF was ticking up and all seemed well in hand. Bell even managed to close the acquisition of MTS in early 2017, and started embarking on a huge build out of a national fiber optic network to leapfrog Telus and Rogers by providing fiber-to-the-home and a backbone of the new national 5G wireless network.

All this cost money, and a lot of it. Looking over my notes, I picked up on cracks in 2021, after reading that they spent a whopping $7B on capex. Coupled with a portion of their legacy high margin business starting to run off, competition with Telus and Rogers, something had to give. They simply weren’t growing and more than doubled their debt pile since 2010:

Stock Unlock: Summary income statement elements for BCE, annual, 2017-2023

Stock Unlock: Financials for BCE, summary income statement 2017-2023 (pulled Sep’24)

Stock Unlock Free Form screenshot for BCE, showing Share Price, FCF, ROIC and Total Debt 2010-2024/09/06 (pulled Sep'24)

Stock Unlock: Free Form for BCE, Share Price, FCF, ROIC and Total Debt 2010-2024/09/06 (pulled Sep’24)

With the share price tumbling, a growing debt pile, anemic growth, and noise over regulation, I decided to pull the trigger and sell out in the Autumn of 2023. It was a difficult decision for a formerly income-focused investor. The fundamental part of me couldn’t rationalize holding it any longer though, especially once it reached the point that they could no longer generate FCF to cover their dividends. That set off alarm bells.

It’s Not Me Darling; It’s You.

My unease wasn’t something I woke up with, but something that grew since about 2020. Management struck me less as stewards of their shareholders’ capital and more interested in their own rewards. They chose to continue to raise the dividend, which wasn’t necessary, instead of taking a harder decision to preserve the company for a long-term benefit. I read that 2023 marked 16th consecutive year of dividend growth. Sounds good, until one realizes that by year-end 2023 they needed to borrow to pay dividends to the tune of at least $600M per year, rising to $900M based on LTM Q2/24. As a result, BCE is creaking under the weight of its debt and recently had its credit rating downgraded to one level above ‘junk’ status.

Management also blamed government regulation for the decision to cut back on investment by $1B over 2024-25. Specifically, they cited having to grant access to their network to wholesalers in Ontario and Quebec. These players may present competition and BCE does not want that. It may be true, but I also think their excuse is disingenuous, and that pointing to regulation was a smokescreen. Using it as a convenient excuse, it enabled them to save face and not have to take accountability for their investment decisions and poor results. As an aside, there is a reason why the UK forced British Telecom to separate the network infrastructure from the retail/service part of the business, into a legally separate entity called Open Reach (link).

These are only two examples of management actions that I disliked (I realize the capex cut came after my sale, but it was being considered ahead of that while I was still a shareholder). Two more examples are:

  1. Taking advantage of corporate welfare to avail itself of some ~$150M of COVID-era funds from the Government of Canada in 2020. BCE did not need this given it’s (then) sufficient FCF, access to the debt capital markets, and drawing over $1B on its revolver during 2020 as a cash backup which it subsequently repaid. Management even admitted, in the public furore that followed the revelation of large Canadian companies taking advantage of CEWS, that the amount of money was immaterial.
  2. Corporate decisions that ran fiber to the CEO’s cottage, while leaving other year-round residents lacking (link).

Of course I don’t believe the CEO is responsible for making every decision, but they are certainly responsible for decisions made in the enterprise. The sum of these actions suggest a corporate culture that I don’t agree with and turned me off the management team.

“In the Long Run, the Market is a Weighing Machine”

It’s fair if one wanted to leave qualitative assessments aside, and look at some numbers instead. I already pointed out above that growth stalled, debt grew, and was further exacerbated by having to borrow more to pay the dividend. Operations were also generating worse returns over this time:

Stock Unlock: Financials/Metrics for BCE (2013-2023)

Taken together, they had underwhelming stock market performance, even well before the Pandemic. This merely continued post-Pandemic, once the euphoria wore off:

Stock Unlock: Returns detail for BCE (2014-Sep’24)

Concluding Remarks / Actions

I don’t think they will go under, but I think it will take years to clean up their capital stack. All the while I don’t expect their stock price will do much, there won’t be as much cash to invest in the business, employees and customers may suffer (even more) cost cutting efforts, and dividends being cut is a very real possibility.

Clearly, there are much better places to put one’s money, whether for income or for growth. This review confirms my decision to get out of this position. I merely wish I had started writing my thesis for each investment sooner (hence part of this blog reviewing each position I have). Had I done this, I’d like to think I would have been in a better position to decide to sell sooner, perhaps with a modest gain. Perhaps not. I haven’t really lost money, just the time this investment could be put elsewhere.

The lesson here I suppose isn’t necessarily that dividend investing is bad, but not having a reason to invest in a company beyond income isn’t inherently prudent, and there is an opportunity cost. I would have done better with almost any other of my investments over this time period.

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