Jerome Hass’ Top Picks for Feb. 21, 2025

Jerome Hass, Portfolio Manager, Lightwater Partners

Focus: Canadian mid-caps

Top Picks: Mainstreet Equity, DRI Healthcare Trust, Secure Waste Infrastructure

MARKET OUTLOOK:

We think game theory is a relevant way to look at the U.S.-Canada tariff war. The 25 per cent general tariff that U.S. President Trump has threatened to impose on Canada and Mexico would be severe if implemented. Nevertheless, markets are putting little weight on the probability of tariffs actually being imposed.

In a multi-stage game, a player is aware of the impact of his reputation on the decision-making of others. So, if Trump does not carry through with his tariff threats, it will impact his reputation in subsequent stages of the game. If ever a player wanted to “invest in reputation” – to use the game theory concept – it makes sense to do so at the earliest possible stage to maximize his benefit in subsequent rounds.

Hence, we believe there is a much higher chance that tariffs are implemented than the market does. Consequently, we are very defensively positioned. We raised our cash levels (35 per cent to 40 per cent) to their highest levels in years and reduced our net equity exposure to 30 per cent.

Markets may have been excited by the prospect of tax cuts and lighter regulation under the Trump administration, but investors generally do not like uncertainty and arbitrary decision-making. We believe markets have gotten ahead of fundamentals year-to-date, so we remain cautious in our market outlook.

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TOP PICKS:

Mainstreet Equity (MEQ TSX)

This $1.9 billion market cap stock is the largest owner and manager of “mid-market” apartment buildings in Western Canada. It is a direct play on population growth in Canada and the scarcity of affordable rental housing. The bulk of its 18,500 units are in Alberta and Saskatchewan where the company is not subject to rent controls. The company has grown by buying “under-performing” (i.e., “run-down”) rental units, refurbishing them with in-house crews, then renting them out at higher rate ($1,200 month avg.). This allows the company to acquire assets at well below their replacement costs ($125,000 per unit vs. $400,000 for new builds). In the latest quarter, 14 per cent of the units in their portfolio are being re-furbished, so the impact is substantial on its net asset value growth. There is little competition from REITs and pension funds in the mid-market sector. The CEO is a rarity in Canada: a manager who grows his cashflows (FFO) by an average of 18 per cent per year since listing in 2000 without an equity raise.

DRI Healthcare Trust (DHT.UN TSX)

DRI has taken a page from the mining sector in replicating their royalty model in the context of pharmaceuticals drugs. DRI owns 28 royalty streams across 21 products. This $666 million market cap stock has a four per cent dividend yield, and it aims to grow earnings organically by six to nine per cent per year. It only invests in drugs that have already been commercialized or have successful Phase III data that are medically necessary, with strong patent protection and are marketed by a leading pharmaceutical company. DRI pays an upfront fee (from $25 to $150 million) then receives a percentage of the drug’s top-line revenues. Costs are borne by the patent holder, so it is an asset-light and high margin business (85 per cent EBITDA margins). The concept of a drug royalty company is relatively new to the stock market (although DRI has been doing this for 34 years). It’s three U.S.-listed peers trade at an average of 3.7x price to book ratio whereas DHT.UN is valued at 1.3x price to book, 4.3x PER, and 4.1x EV/EBITDA with a 4.2 per cent dividend yield. Conversely, mining royalty companies such as Franco-Nevada trade at 4.8x price to book with a one per cent dividend yield.

Secure Waste Infrastructure (SES TSX)

SES is a waste services company in Western Canada with a $3.5 billion market cap stock and a 2.7 per cent yield. When we first met SES in January 2024, we thought the company had a terrible name: Secure Energy Services. About 70 per cent of its earnings are industrial waste processing and transfer treatment, industrial landfill, and metal recycling, while only 30 per cent is energy infrastructure such as water treatment from oil wells and mid-stream facilities. The “energy services” handle was misleading and led to a lower valuation. We like its stable cashflow and high level of recurring revenues (80 per cent). Partly due to its prior name, SES was valued as an energy services company rather than a waste management company. On January 1, 2025, the company corrected that problem. SES trades at roughly 8x EV/EBITDA while its waste management peers trade at 17x, hence we see considerable upside. We also love its capital discipline. Last year SES bought back 19 per cent of its shares under a Substantial Issuer Bid (SIB) and an additional 7.9 per cent under its NCIB last year. Management is guiding to buy-back 8.2 per cent of its shares in 2025.