Investor’s Digest recently reported on Calgary-based Acumen Capital analysts Brian Pow, Nick Corcoran and Ted Bobier’s five favourite growth stock candidates for 2018.
Early trading in 2018 showed strong market gains and stock index records, spurred on by strong economic data from the world’s largest economies. With most of the macro indicators signaling that the world’s economies are doing well, it looks like the stage is being set for continued market strength, supported by reasonable underlying corporate fundamentals.
We believe this is encouraging for Acumen Capital’s small cap universe. We expect corporate earnings reports in the coming months will support further upward revisions to estimates and target prices.
While we expect reasonable performance in 2018, we are tempering our expectations for returns this year. As we build the list, we are focused on higher-quality names that performed reasonably well in 2017. We also showcase a few names that have been transitioning their businesses, with expectations that 2018 performance will reflect the benefits of these initiatives. Our focus is on fundamentals, potential catalysts, and valuations.
However, one must also keep in mind the macroeconomic factors of investing in 2018. The recent uptick in inflation is gaining momentum and changes the current market sentiment. Given the many years of limited pricing power, investors are discounting the potential impact inflation could have in 2018 and beyond.
Wage growth, commodity price increases, and potential supply constraints seem more likely, which in turn, would affect inflation. As a result, we expect to see further interest rate increases in 2018 to (keep up with inflation and) try to keep the system in balance. We still expect a supportive backdrop for reasonable growth.
Investors should also be focused on the potential impact of the US tax reform on Canadian companies with exposure to the American market. Be mindful that some of the impact has already been priced into the shares.
As we write this, the feedback from our coverage list of companies is that it is still early days to figure out how it will exactly impact them. There are also potential headwinds later in the year if central banks take steps (for example, raising interest rates) to combat inflation.
Organic growth plus acquisitions for Peller
The first of our top 2018 picks with a market capitalization under $1 billion is Grimsby, Ontario-based consumer stock Andrew Peller Ltd. (TSX—ADW.A). Andrew Peller Ltd. is engaged in the production, bottling and marketing of wines and wine-related products in Canada. Its brands include Sandhill, Peller, Red Rooster, Calona, Thirty Bench Wine, Vineco, Winexpert and Artful Winemaker.
Peller is a brand-building exercise by an experienced management team. We believe operational improvements, strong organic growth, and the acquisition of three wineries in British Columbia will set the stage for a strong 2018.
K-Bro acquires leading UK commercial laundry provider
Our second top pick is dry-cleaning and laundry services stock K-Bro Linen Inc. (TSX—KBL). K-Bro Linen Inc. provides linen services to healthcare institutions, hotels and other commercial accounts that include the processing, management and distribution of general linen and operating room linen.
Edmonton-based KBL was active in the first half of 2017 with the commissioning of its new Toronto facility, which established the company as the lowest-cost operator in the Toronto market and helped with some competitive health-care contract wins.
We believe KBL is well-positioned in the Toronto market for further gains in 2018. The company also completed a transformative transaction in November 2017 with the acquisition of UK-based Fishers Topco Ltd., thereby adding an established network of processing facilities in a geography that is ripe for consolidation.
For 2018, the commissioning of the Vancouver facilities in the first half of the year will weigh on performance (as it did for the Toronto facility), but we expect Canadian margins to be at new levels by early 2019.
Consumer services stock provides funeral and memorial services
Our third pick is funeral services company Park Lawn Corp. (TSX—PLC). Park Lawn owns and operates cemeteries, crematoriums and funeral homes across Canada. In 2017 PLC was active with acquisitions, including the completion of its second US transaction.
We expect the performance in 2018 will benefit from the larger scale of the business, integration initiatives, and further acquisitions. A recharged balance sheet and growing competitive advantages set the stage for above-industry average growth over the next couple of years.
The big game changer for PLC was the purchase of Saber Management LLC for US$48.8 million in June. The acquisition added 19 cemeteries and four funeral homes in Kentucky, Illinois and Texas.
An acquisitive management consulting services stock
Our fourth pick is business and management consulting services stock People Corp. (TSXV—PEO). People Corp. is engaged in the delivery of employee group benefit consulting, pension consulting and third-party benefits administration services, recruiting services, strategic human resources consulting and career management services.
PEO had a successful 2017 and carries strong momentum into 2018. Management has a comprehensive game plan to grow the business and increase its market share through acquisitions and organic growth.
After a couple of acquisitions last year, we believe that the company will have another active year for acquisitions, providing numerous catalysts for the shares.
In April 2017, PEO acquired Winnipeg-based Sirius Benefit Plans Inc. for $15 million. In November 2017, PEO announced the acquisition of Quebec-based Assurances Dalbec Ltée (ADL) for $16.1 million.
Both are leading providers of third-party administration and third-party payor services to small-and medium-sized businesses. This is PEO’s first foray into the Quebec market with the deal closing by the end of the second fiscal quarter of 2018 (period ending Feb. 28, 2018).
Also during November 2017, PEO issued 3.8 million shares (including full over-allotment of 500,000 shares that was exercised in full) at $6.70 a share for gross proceeds of $25.3 million. The financing was announced at the same time as the acquisition of ADL.
With the completion of these acquisitions plus equity financing, the stock is showing growth potential ahead of its underlying markets, with organic growth expected to be between five per cent and 10 per cent.
We believe that the company will show additional operational improvement and have another active year with further acquisitions. Based on the fiscal 2017 fourth-quarter results (quarter ended Aug. 31, 2017), PEO had $24.5 million of capacity available to fund more acquisitions.
Steady growth, not ‘Lady Luck’ is consumer stock’s strategy
Last, but not least, our top picks for companies with less than $1 billion in market capitalization is Winnipeg-based gambling industries stock Pollard Banknote Ltd. (TSX—PBL). It was a relatively unknown stock almost a year ago, but is now one of the most compelling names in our universe.
Pollard Banknote Ltd. is engaged in the manufacture, development and sale of lottery and gaming products. It also provides instant tickets and lottery services, including licensed products, distribution, retail telephone selling and marketing.
PBL was our strongest performer last year, ending 2017 up 114.3 per cent since we initiated coverage in December 2016. The acquisition of Innova Gaming Group Inc. also brought attention to the stock.
We are modelling further growth in 2018. We expect revenue to go up 15.5 per cent year-over-year to $325.5 million and EBITDA (earnings before interest, taxes, depreciation and amortization) to go up 24.5 per cent year-over-year to $51.8 million.
As we write this note, the stock continues to set new highs as investors read into the near-term outlook. We remain constructive on the name as the valuation remains reasonable in the context of historical levels and its peers.
Brian Pow, Nick Corcoran and Ted Bobier are equity analysts for Calgary-based Acumen Capital.
This is an edited version of an article that was originally published for subscribers in the February 9, 2018, issue of Investor’s Digest of Canada. You can profit from the award-winning advice subscribers receive regularly in Investor’s Digest of Canada.
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