July 27, 2015

Second Quarter 2015 Letter


During the second quarter of 2015, the Lester Canadian Equity Fund returned +2.3% (net of all fees and expenses) versus -1.6% for the TSX Composite total return including dividends. Year to date, the Fund’s return is -0.8% versus +0.9% for the TSX. Since inception in July 2006, our equity strategy has produced a cumulative net return of +154.2%, over double the +62.2% for the TSX. This represents a compound net return of +10.9% per year over nine years versus +5.5% for the TSX. Our outperformance in the down market during the 2nd quarter was due to our cautious stance having low weightings in the Energy and Materials sectors and holding higher cash balances, and from strong performances by several small and mid-cap positions. We are confident that our portfolio holds significant value and upside with lower risk than the overall market, and that patience will be rewarded.

Notable winners and losers during the 2nd quarter included:

  • Neulion (+54.3%): Live sports streaming technology provider’s stock rose sharply after reporting strong first quarter 2015 results. We took advantage of the strength to trim part of our position.
  • Com Dev (+33.9%): Announced significant partnership with Harris Corp and spin-off of ExactEarth.
  • Logistec (+32%): Benefitting from US economy and plans to double Montreal container port facilities.
  • D-Box (+31.2%): Announced record results and should benefit from strong action movie slate in 2015.
  • Andrew Peller (+11.6%): Announced strong fiscal 2015 results and raised its dividend.
  • Direct Cash (-21.5%): Declined due to concerns related to lower ATM volumes in Australia.
  • Corus (-13.4%): Sold-off due to lower than expected advertising revenues in radio and TV broadcasting.
  • Input Capital (-11.5%): Down due to concerns of impact of drought in Western Canada on canola crops.
  • TVA Group (-10.1%): Dropped following rights issue and poor results in magazines and film production.
  • Fortis (-9.1%): Electric and gas utility company’s stock sold-off on concerns of higher interest rates.

Among the winners, we invested in satellite component manufacturer Com Dev in early 2013 when we assessed that its value was being held back by declining military contracts and investment in a new venture. We believed not only that its core satellite business was undervalued but that its new data services venture ExactEarth would grow to be worth several dollars per share. It took several years for the market to realize this and Com Dev’s stock price has risen 50% this year. Among the losers, Direct Cash (DCI) has grown to become the largest independent ATM provider in Canada and Australia, and the 2nd largest in the UK. Investors punished DCI in the past 2 years due to the bankruptcy of one of its large customers for whom it supplied pre-paid debit cards and concerns over emerging payment technologies. Yet Canadians still love their ATMs and DCI’s profit per ATM has increased. Direct Cash has also expanded into payment processing, generates strong recurring free cash flow, and pays large dividends at a low pay-out ratio while trading at a very inexpensive multiple to free cash flow.

For several years now, we have said that we believe that interest rates will stay lower for longer, and indeed this has been the case with at least 24 countries including Canada having recently cut interest rates to stimulate economic growth. In Canada, the decline in oil prices coupled with lower growth in China has caused a major slow-down in the resource sector. Only the US and the UK are likely to raise rates, which is propelling their currencies higher, however their central banks are being cautious given the fragile state of the global economy. Given this backdrop, we continue to believe that dividend yield is an important part of equity returns, and thus continue to hold large cap dividend stocks (Telecom, Utilities, Renewable Energy and Infrastructure) and a diversified mix of small/mid-cap value stocks, most of which also pay dividends. As well, we have positioned the portfolio such that around 50% of our holdings benefit from a strong US$, being either manufacturers/exporters or having a growing portion of their earnings or assets in the US. Examples of such companies include Algonquin Power & Utilities, Logistec, CCL Industries, Newalta, Velan, Com Dev, Neulion, Ag Growth, Badger Daylighting, Conifex Timber, BSM Technologies, D-Box, Questor, Prism Medical, Savaria, Sandvine and Ten Peaks Coffee.


Q2 was a stock picker’s market as the US markets showed no signs of having any clear direction and traded in a tight range before dropping at the end of the quarter. It was actually the first down quarter (before dividends) for the SP500 since Q4 2012. That consistency is remarkable and shows just how linear this bull market has been. Our US strategy returned 2.1% including dividends in the quarter, vs 0.3% for the SP500 and year to date we are up 5.9% vs 1.2% for the SP500. In the same periods the Russel 2000 returned 0.4% and 4.8% respectively. The Russel continues to outperform as these smaller companies tend to be much more tied to the US economy, which has been one of the strongest economies worldwide for the past few years.

We can almost reprint what we wrote about our stocks in Q1 as both T-Mobile and Starz continued to be among our top performers. T-Mobile reported solid results but also rose on speculation that it may be acquired by Dish, the satellite TV company. We could see Dish making this move as its current business is in a state of irreversible decline and T-Mobile has been the fastest growing telco over the past 2 years. Starz rose on good subscriber additions and the breakout of another original production, Power. Part of the thesis on this investment was the CEO, Chris Albrecht, could recreate the magic of making great originals that he showed off while at HBO. So far he has delivered.

One of the investments that dropped in the quarter was Dillard’s. We had previously sold half our Dillard’s earlier in the year as the stock was approaching full value, but now it is getting close to the point where we may rebuy the position we sold. It is still a well-run high end department store with valuable real estate not being properly valued by the market. We’ll keep a close eye on it. We did not do any major buys or sells in the quarter, as the markets stayed expensive in general. We have a few companies on our watch list that we will purchase if the shares drop to a point where the margin of safety (downside protection) is large enough.


Our dollar weighted average return on fixed income was 1.5% in the quarter and 4% YTD. Individual account performance varied from this, depending on cash balances, weightings and management fees. In the quarter, we outperformed the negative returns of the benchmarks (Canadian Bond Universe -1.76% and FTSE TMX Canada HYBrid Bond Index -.35%) due to our short duration of about 4 years, compared to the benchmarks at 7.4 and 6 years respectively. Bond yields rose in the quarter from unsustainable levels and longer duration bonds corrected after the first quarter rally. We continue to believe that the next significant move in interest rates is up, so we are content to forego some potential capital gains on bonds in the short term, with the goal of protecting capital when interest rates inevitably rise.

The portfolios are invested exclusively in corporate bonds, both investment grade and high yield, with average yields close to 6%. To achieve fixed income returns today, we continue to prefer to do our research and take the credit risks of our bonds, rather than extend term with the commensurate interest rate risk of government bonds.

The Iran Deal – What Does it Mean for Oil

It seems that everyone these days has an opinion about the geo-political ramifications of a deal with Iran. Certainly the thought of Iran with nuclear bomb capabilities is disheartening to many and especially to Israel and other countries in the Middle East and its surroundings. Whenever there is a major change to the balance of power in any given region there are always consequences; some positive and some negative (depending on your perspective, of course). As well, there are consequences that are somewhat foreseen and those that are not and it is clearly the negative, unforeseen ones that the impacted stakeholders worry about. If you are an oil producing country (like Canada) or an oil company, then a foreseen negative consequence of an Iran deal will be that it allows Iran to sell their much talked about stockpile of anywhere between 7 and 35 million barrels (depending on who you believe) of oil and to ramp up production up to an incremental one million barrels of oil per day.

To put this in proper perspective, the world burns through about 92 million barrels of oil every day. The stockpile, which is likely 10-15 million barrels, even if put out on the market in a hurry, would cause a temporary disruption with oil prices falling to account for the increased supply, but that would likely only last for a few weeks. In terms of production, the dormant Iranian oil fields are in huge disrepair and need massive capital expenditures and considerable time to bring them into production. Even if all goes as well as possible, experts are saying that Iran is likely to take about a year before they can ramp up to an extra 200-300 thousand barrels and then perhaps another year to get to around 600 thousand barrels, with Iran getting to the million mark of increased production in year 3 or 4. Again note that this is the best case scenario for Iran. What is more likely to happen is that there will be ongoing problems and disputes with the deal, especially related to the monitoring of Iran’s nuclear initiatives as well as many hiccups in the rebuilding of their dormant wells. This is not something that should be spooking the oil industry.

Greece – A personal Anecdote from our CEO

Much has been said and written about the Greek-Eurozone debacle so I will only add a few personal opinions and feelings. As many of you know, my late mother was Greek and my family spent many summers there as I was growing up. Indeed, Greek was my first language. To me this is a classic case of what happens when citizens stop behaving as responsible citizens and instead act only in their own self-interest. Paying taxes is an obvious example of being a responsible citizen and the fact that tax evasion had become the national pastime in Greece is well known. In fact, if they could even collect the taxes that are currently due, that would go a long way towards solving the financial problems that the government of Greece faces. There are certainly many reasons why we are in this position today and many of the reasons have nothing to do with Greece per se, but more to do with the concept of a central currency with no central bank policies. However, here I will focus, using a personal anecdote, on one of the major problems in Greece and that is the collection of taxes.

In 1976, while still in college, I spent the summer working in a luxury hotel in Crete. Over the four months I met many Greek business people related to tourism and would ask them frequently how their business was going since my family was contemplating developing a hotel on some land that we owned there. The response I got from everyone without exception was that business was horrible and that they were barely solvent.

Towards the end of the summer, one of my Greek uncles came to visit me and I told him the horrible news; that Crete, despite the fact that tourism was actually up that summer, was doomed because all the businesses were struggling and that we should therefore not consider building a new hotel there. My uncle asked me where I got that information. When I told him he laughed and said; never listen to Greeks when they talk about their business. He went on to explain that Greeks will always say that their business is bad because they are afraid if the truth came out, they would have to pay taxes.

In fact, even though they pretty much are all cheating on their taxes, they figure everyone around them is cheating even more so there is complete distrust and no one tells the truth. That is crazy, I said. Do they not realize that the government is THEM?? Apparently not, said my uncle.

How this plays out…or ends is hard to even contemplate. These are, very much, uncharted waters. Regardless of the outcome, Greeks, including the vast majority who never benefitted from the largesse and rampant corruption, will suffer. Perhaps the only good that can come out of this, is as a warning to the rest of the world of what can happen when citizens stop behaving like responsible citizens.


In the very-good-news department (no we are not lowering our fees), we are happy to report that our latest and much younger partner, Jordan Steiner, proposed to his girlfriend of many years, Michelle, and she (surprisingly ?) said yes. The nuptials are planned for next July and I am sure that you join us in wishing the very best to Jordan and Michelle.

Ken Lester, Stephen Takacsy, Peter Dlouhy