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August 16, 2023

Commentary: NCM Dividend Champions

On August 16, 2023, portfolio manager Michael Simpson, CFA provided his latest market outlook and highlighted some recent portfolio activity on the heels of Q2 earnings season.


Hello, everyone. My name is Michael Simpson and it is Wednesday, August 16th, 2023. And we are in the final dog days of summer. I am the portfolio manager of the NCM Dividend Champions Fund.

Investing in 2023 has been like being on a on a seesaw. You all remember that fun ride or fun piece of equipment in the parks when we were children? We've had up days followed by down days for the majority of the market. Volatility, generally speaking, up until the early days of August has been very low and minimal.

While market participants debate whether the economy will have a soft or hard landing or no landing at all, as of July 31st, the S&P 500 was up 20%, the S&P TSX 8.4%, and the Dow Jones Industrial Average 8.5%. The Atlanta Federal Reserve GDP forecast is currently forecasting growth in the US economy of 5%. This is very far from a recession. Forecasting the economy is fraught with trepidation and unknown outcomes. That's why we don't do it.

In Canada, the main inflation gauge CPI rose 3.3% year over year in July, following a 2.8% increase in June. That's above the long range target for the Central Bank of Canada, where they'd like to see inflation at 2%. Excluding gasoline, the CPI in Canada rose 4.1%. We've all noticed interest rates rise over the last 18 months and the mortgage interest cost index was up 30%. That's 30%. That's the impact of rising interest rates. And it posted another record year over year gain and remained the largest contributor to headline inflation. Although many people may not believe it. Grocery prices, although still very high, grew at a slower pace year over year, rising 8.5% in July after a 9.1% increase in June. On a provincial basis in Canada, Quebec has the distinction of having the highest inflation rate at 3.9%.

In the U.S., indicating that the consumer is still alive and well and vibrant, U.S. retail sales rose 0.7% in the month of July. Canadian retail sales for July are not out yet, but our thoughts are we expect them to be weaker than in the U.S. What we're hearing from companies that we follow is that consumer spending is slowing, especially on luxury and expensive items and more dollars are being spent on basic and essential items. Also, although the supply chain has improved, several companies have told us that there's a long wait for trucks that they had ordered.

A key question you may ask is how do you get updates on the companies that you invest in? The answer is through quarterly earnings reports, conference calls and meetings with management at different industry conferences.

As we're almost finished Q2 earnings season. Sometimes companies earnings meet our expectations and sometimes they disappoint and get an immediate, visceral negative reaction in the market. One company that we own that had disappointing earnings in the view of the market is Calian Group. You may not have heard of Calian Group but Calian is an Ottawa based company that has four divisions I.T. and cybersecurity, advanced technologies and learning and health care.

I will briefly talk about the divisions of Calian. The I.T. and Cyber Division helps companies with their hardware and software needs. Cybersecurity is growing very quickly as more companies face cyber threats. Health primarily provides doctors and nurses in remote communities and provides pharmacies and large retail settings in drugstores. Advanced Technologies provides equipment for satellites and the defense industry.The Learning Division, which is the smallest division, provides training modules for defense departments, governments and commercial industries.

What happened when Calian reported their third quarter results? Here are some highlights. Revenue was up 11%. Gross margin above 30% for the fifth quarter in a row and had new contract signings of 131 million. So far, this seems all good news. You may be saying, “What's going on?” But as the market looks forward, the market is a leading indicator. It did not like that Calian updated their 2023 guidance and reduce their EBITDA forecast. The new guidance range was for a range of EBITDA from 60 to 65 million. This was down about 10 million from the earlier guidance.

What the market ignored was that Calian implemented a restructuring plan which will lead to savings of 8 million. You see all companies make mistakes. If the mistakes are minor or small, they can be corrected. Calian had overinvested in their sales team and R&D initiatives and it was now prudently scaling back. Over the course of two days, Calian Group had lost about 120 million in market cap over the loss of 2 million EBITDA. So that's a 10 million reduction in EBITDA, but 8 million in savings from their reduction in their sales force and also scaling back R&D.

Calian still has the ability to make acquisitions and grow revenues, cash flows and their dividend. This to us represented a strong buying opportunity and we went in and bought. We had the resolve to buy. This seemed too extreme and harsh to us, the market's reaction to the earnings. And as a result we're buying when the stock was declining.

It's not always easy for investors to buy when a stock's declining, but that's in many cases, that's how we've got some of our best opportunities over the over the last two decades. Calian is just one name in a portfolio of approximately 40 names. We like to run the NCM Dividend Champions Fund as a concentrated portfolio so we can get through earnings season and know all our companies very well.

Trying to predict a recession is wasted energy and best left to economists and strategists. We try and look at the forests and we see slower growth and a consumer that is getting tired and a little fatigued. In that vein, we look for companies that have strong balance sheets, good cash flows and the ability to raise their dividend.

We are looking for companies that provide more essential services. A health care, transportation, logistic provider that transports medicines, vaccines and gene therapies over general freight. Because what we've noticed over the last three or four months from the rail companies, from the trucking companies, is that there's been a freight recession, hasn't made the headlines of the newspapers, but you could see it in the truck volumes, the rail volumes and also the trucking spot rates are moving freight. In this category we favor Andlauer Healthcare.

Andlauer Healthcare is formed by a dynamic entrepreneur, Michael Andlauer and they have a dominant position in the logistics health care business in Canada. And about a year ago, they expanded into the U.S. with the acquisition of Skeleton, and now they're starting to transport blood supplies in the U.S., where companies and government authorities need a trusted carrier to do this. Although we may be close to the bottom of the freight recession, we have reduced our weights to the railroads and general trucking. We want more specialized plays like Andlauer Healthcare.

Central bankers are on a zealous quest to defeat inflation. But along the way, some over-levered companies and consumers may be hurt. Our best forecasts for rate reductions is March of 2024. In September, interest rates will have been on the rise for 18 months.

The NCM Dividend Champion Fund is positioned to withstand shocks and will continue to provide income and search for the best dividend generating companies. Remember, a lower stock price comes with a higher yield. Some of our recent successes in the Dividend Champions Fund, Capital Power recently raised two divided by 6% and Tourmaline declared a special dividend of $1. Good treats for patient investors. We'd like to wish you a happy and healthy summer and everyone, please enjoy the rest of the summer, wherever you may be.


The information in this video is current as of August 16, 2023 but is subject to change. The contents of this video (including facts, opinions, descriptions of or references to, products or securities) are for informational purposes only and are not intended to provide financial, legal, accounting or tax advice and should not be relied upon in that regard. The communication may contain forward-looking statements which are not guarantees of future performance. Forward-looking statements involve inherent risk and uncertainties, so it is possible that predictions, forecasts, projections and other forward-looking statements will not be achieved. Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.



Michael Simpson, CFA

Michael is one of Canada's most accomplished dividend investors and the Portfolio Manager of NCM Dividend Champions.