You may have seen pipeline-related news from Calgary this summer – not energy pipelines but, more surprisingly, water pipelines. In short, the city’s water pipeline infrastructure that was expected to have a 100-year life began to fail critically after 50 years. While a happy happenstance for some kids to further eschew showers, it was a raw deal for the city. It paid for a 100-year asset life and instead got bad luck, a 50-year asset life, heavy water restrictions and a huge bill.
This issue raises one of the largest risks faced by investors – not getting what you paid for. Henry Kravis, the leveraged buy-out pioneer, said, “Any fool can buy a company.” While there is a lot of external ballyhoo in our industry, including what peers and the markets are doing, these factors remain completely out of an investor’s control. What is in your control is what you choose to own. Therefore, your biggest threat to future investment performance is most likely staring back at you in the mirror. Overpayment, analytical missteps, judgement lapses and psychological biases are amongst the many unforced errors that investors face day-to-day.
So how can we do better when we know investors are often their own worst enemy? In our view, the right framework deployed consistently is at the crux of mitigating idiocy. In other words, we can minimize the odds of not getting what we paid for by using a clear, consistent framework prior to buying a business.
One simple framework is to ask three questions:
1) Does this business have the right profile?
2) Are we partnering with the right people?
3) Are we paying the right price?
Avoiding unforced errors and avoidable mistakes is at least half the battle, if not more, of winning. Reviewing Canadian small cap holding Winpak through the above three filters can provide clarity on why it is a top three weight in the strategy.
Does this business have the right profile?
With a relative lack of consumer staples-oriented businesses in the Canadian small cap space, Winpak (WPK) stands out as a North American manufacturer of packaging materials. The company generates ~80% of sales from the US, with customers across the food, beverage and healthcare industries. Over the past decade, it has generated 4.8%/annum in revenue growth, and ~7.6%/annum in earnings growth. Due to its stable demand profile from end customers, Winpak rates well on defensibility and our stress tests for more difficult environments. Additionally, despite WPK’s smaller size, its 20% EBITDA margins in 2023 are more than 30% better than reported profitability metrics of some of its much larger peers in the industry. In conjunction with its net cash balance sheet and recent heavy investments, we anticipate a resilient cash generator that is poised to match or exceed its results from the past decade.
Is this business led by the right people?
The portfolio today benefits from the many exceptional businesspeople we have partnered with who are ‘sweating’ the businesses on behalf of stakeholders. We believe it is important to partner with and delegate to good operators who will allocate capital in a reasonable fashion and manage the strategy and balance sheet appropriately. In Winpak’s case, there are checks on all fronts. Former CEO Bruce Berry is on the board and well known to QV, insiders own close to 53% of the firm, and the current CEO Olivier Muggli has been in place since 2017. Mr. Muggli has research & development experience at one of the largest peers in the world. He has also stewarded the company through operational and customer challenges while focusing on innovative products that have begun to help the company win share with some of the largest companies in the world. We anticipate continued sound stewardship and potentially accelerating and improving financial results as the company embarks on the largest multi-year investment program in its long history.
Are we paying the right price?
Great companies can be poor investments if you overpay, while so-so companies can be great investments if bought at the right price. In general, paying a fair price for a high-quality opportunity is likely to result in a favorable long-term tilt. In Winpak’s case, we believe the margin of safety is high. Based on its current valuation, it seems priced for imperfection or lower results than its long-term record. Trading at 13.3x estimated earnings, Winpak is trading at more than a 25% discount to its own 10-year historic average and is also cheaper than the overall market. Utilizing various measures to estimate free cash flow (FCF), the company is offering a 6-9% FCF yield on our proxy for owner’s earnings. In conjunction with an organic revenue growth outlook in the 3-6% range, we see substantial value, alongside solid and underappreciated growth potential.
An early mentor provided me with a simple acronym with which to approach problem solving: KISS. Keep It Simple Stupid. Within the Canadian small cap arena, the portfolio is well-positioned in sound investment opportunities, which we have been incrementally adding to. We’ve tried to engineer out or mitigate the likelihood of being foolish through a simple (but not easy) approach to the investment problem. Fortunately, the market is currently providing an opportunity set from which we expect favorable investment outcomes relative to what we are paying. As a result, we may be looking back in 5 years and wondering how “lucky” we were, while keeping it simple and avoiding foolishness.
