Market Call for Wednesday, May 17, 2017
Cameron Hurst, chief investment officer at Equium Capital Management
Focus: U.S. equities
There’s significant discussion right now about low correlations and this being a stock-pickers market, but we have a different take on what’s happening in markets:
- It’s definitely true that to have a better chance of beating the market you need the dispersion of stock returns to widen out so there are relative winners for you to pick.
- But what’s interesting is the number of clients and investors we speak with that feel they have had good success picking stocks over the long term compared to the success of professional equity fund managers.
- When you look at the portfolios of successful individual investors, quite frequently they’ve stuck with safer and higher-yielding sectors that traditionally experience less volatility and loss during weak markets.
- Typically, successful individuals, like professional managers, have had winners and losers.
- But looking at the same personal portfolio through a factor lens, what you see is a very concentrated bet on rates because they’re heavily invested in bond proxies.
- Chart showing consumer staples versus 10-year Treasury yield shows the primary driver behind bond proxy success.
- Is that really stock-picking and were they aware of the embedded risks they were taking?
- Leaving risk management aside for a second, we would argue that technology and improved regulation have all but closed the gap for professional managers to out-research, out-trade and generally out-pace well-informed, individual investors picking stocks.
- “Alpha” is marginal now, on average, at hedge funds.
- Chronic underperformance of long-only professional managers picking stocks in traditional stock-picking fund structures.
- How, then, can we be active managers and still challenge the dogma of traditional stock-pickers?
- Risk management is never something that should be left aside, for the record, so let’s be clear that we believe our greatest value proposition is our demonstrated ability to get you out of harm’s way by allocating capital accordingly.
- Plainly speaking, this is active management. The simple idea we had in starting Equium Capital was to build a fund within the construct of active management that allows us to go to cash or bonds when things get rough in equity markets; that allows us to shift capital to the strongest geographies around the world when they’re performing better, and to do this in the most cost-efficient and risk-conscious manner possible.
- On a YTD basis, in CAD, U.S. energy is -8 per cent; S&P500 is +9 per cent; U.S. tech is +21 per cent.
- S&P/TSX Composite, YTD, is only up +3 per cent.
- Germany and France, YTD in CAD, are up +18 per cent and +19 per cent respectively.
Within this context, it shouldn’t be surprising that we have significant exposure to Europe, we’re underweight Canada, and energy globally, and we are overweight technology and health care. We were overweight financials as well, but our process reduced the exposure when rates turned earlier in the year. As we suggest, you can’t get them all right — but taking out the idiosyncratic risk can dramatically improve risk mitigation and long-term returns. From the perspective of our process, earnings shone through brilliantly last quarter, credit spreads remain supportive for risk assets and global growth continues to improve. Portfolios remain tilted towards risk assets and focused in the leading sectors and countries at this point.
ABBOTT LABORATORIES (ABT.N)
- Sector: Health care
- Market cap: $76.4 billion
- 1 year absolute: +19%
- 1 year versus Health care: +8%
- 1 year versus S&P 500: -1%
- Top-line growth: FY17 27%; FY18 5%
- Bottom-line growth: FY17 +12%; FY18 +11%
- P/E multiple: FY17 17.8x; FY18 16.0x
- Positive on industry (safe haven) and ABT is a leadership name in the group.
- Good diversification: devices, diagnostics, nutritionals and pharma
- St. Jude acquisition highly complementary ($0.21 accretion); broadens ABT’s business in high-growth area of cardiovascular
- Margin expansion opportunities and strong synergies from St. Jude
- Exposed to positive secular themes in medical devices eg. lifestyle diseases (structural heart and diabetes).
- Notable drag from pediatric nutrition in China, but this affects less than 10 per cent of revenue and management is working on it.
- Strong quarter that beat top line and bottom line.
- Driven by medical devices (4.5 per cent growth) and pharma (5.7 per cent growth).
- Reiterated guidance: mid-single digit sales growth and double-digit earnings growth (STJ accretion)
- January 2017: completed acquisition St. Jude Medical.
- STJ positions in areas such as atrial fibrillation, heart failure, structural heart and chronic pain complement Abbott's positions in coronary interventions and mitral valve disease.
ALPHABET INC. (GOOGL.O)
- Sector: Info tech
- Market cap: $655 billion
- 1 year absolute: +34%
- 1 year versus Technology: -5.7%
- 1 year versus S&P 500: +14%
- Top-line growth: CY16 +21%; CY17 +20%; CY18 +16%
- Bottom-line growth: CY16 +21%; CY17 +48%; CY18 +18%
- P/E multiple: CY17 23.1x; CY18 19.7x
- Technology continues to screen favourably in our process.
- Core advertising business continues to be strong (+19 per cent y/y in Q117; 66 per cent of ad spend still offline). Google Sites +21 per cent. Secular digital ad growth and mobile usage highly likely to continue driving superior earnings growth on their own.
- Beyond the core, cloud service is growing rapidly with significant opportunity ahead (and within an oligopoly with AMZN, MSFT). Machine learning, AI and autonomous driving are also significant initiatives for Alphabet but with uncertain future.
- Management getting “Other Bet” spending under control (paused Google Fiber expansion), which should reduce the current $4-billion drag on operating income (approximately 10 per cent of total).
- Significant international exposure (53 per cent of sales) could be hit by stronger USD but helped by tax repatriation holiday ($83 billion cash, 13 per cent of cap).
- Valuation of 23x near long-term averages (21x), approximately 1x PEG, and slightly below historical relative premium to S&P.
- Sector: Info tech
- Market cap: $215 billion
- 1 year absolute: +22.0%
- 1 year versus Technology: -17.6%
- 1 year versus S&P 500: +2.3%
- Top-line growth: CY16 +14%; CY17 +14%; CY18 +10%
- Bottom-line growth: CY16 +12%; CY17 +15%; CY18 +14%
- P/E multiple: CY17 26.8x; CY18 23.4x
- As technology and spending patterns evolve, we really like fintech and the payments space in general.
- Visa bought in Europe so it’s a more complex company now with FX and currency head/tailwinds.
- Raised 2H’17 guidance on deal mechanics; more growth potential and room for cost saves.
- Visa’s U.S. volumes grew almost four percentage points faster than Mastercard in 2016 due to several major partnership wins.
- U.S. purchase volume +10.9 per cent at Visa versus +6.4 per cent at Mastercard.
- You’re getting a couple extra percentage points growth out of Visa now, so rotating from Mastercard makes sense.
- Not cheap, but high-quality franchise with huge moats and a long (and growing) runway justify the lofty low-20s P/E and 1.3x PEG.
- Returned 116 per cent of net income in dividends and repo.
PAST PICKS: APRIL 13, 2016
- Sector: Info tech
- Market cap: $127 billion
- 1 year absolute: +25%
- 1 year versus Technology: -7.2%
- 1 year versus S&P 500: +6.8%
- Top-line growth: CY16 +11%; CY17 +12%; CY18 +11%
- Bottom-line growth: CY16 +10%; CY17 +14%; CY18 +16%
- P/E multiple: CY17 27.6x; CY18 23.7x
- We like both major processors, but feel Visa is probably the way to go at present (see Top Pick No. 3).
- The business is highly defensible and is characterized by recurring revenue, high incremental margins, low capital and high free cash flow.
- Broadly speaking, fintech payments space face evolving spending patterns.
- Mastercard Services business is now 25 per cent of revenue and a real growth contributor at 18 per cent organic growth over the last few years. E.g. Mastercard Advisors helps business with data analysis and consulting.
- Mastercard trades at about the same level as Visa, but is seeing less growth and has already taken significant costs out of EU franchise.
- Then: $95.75
- Now: $117.27
- Return: 22.47%
- TR: 23.46%
- Sector: Consumer staples
- Market cap: $187 billion
- 1 year absolute: -1.5%
- 1 year versus Staples: -33%
- 1 year versus S&P 500: -20%
- Top-line growth: CY16 -5%; CY17 -16%; CY18 -12%
- Bottom-line growth: CY16 -7%; CY17 -1%; CY18 +5%
- P/E multiple: CY17 23.2x; CY18 22.1x
- KO has underperformed over the prior 12 months as the overall market rallied driving cyclical outperformance relative to the Staples sector.
- Also as a large multi-national, KO was impacted by the slowdown in emerging markets as well as a stronger USD, which weighed on revenue growth.
- From a micro perspective, KO continues to pursue its structural change agenda with the sale of its asset-intensive bottling operations and further cost savings due to the adoption of Zero Based Budgeting (ZBB).
- Although we like the new CEO, James Quincey, and see a sustainable path to higher ROIC and cash returns to shareholders, we are negative on Staples generally and expect turnaround efforts at KO to take time before driving earnings materially higher.
- Then: $46.04
- Now: $43.96
- Return: -4.50%
- TR: -1.28%
- Sector: Info tech
- Market cap: $26 billion
- 1 year absolute: +19%
- 1 year versus Technology: -13%
- 1 year versus S&P 500: +1.5%
- Top-line growth: CY16 +5%; CY17 +5%; CY18 +5%
- Bottom-line growth: CY16 +19%; CY17 +29%; CY18 +12%
- P/E multiple: CY17 23.6x; CY18 21.1x
- FISV has paced the market over the last 12 months though underperformed the very strong move in Technology generally.
- High recurring revenue and exposed to areas of need such as mobile banking, alternative lending, chip cards and branch transformations. Financial Services IT spending expected to be positive mid-single digit growth on average, which is in-line with long-term four to eight per cent guidance.
- Bank IT spending should be helped by a better earnings outlook (higher rates and lower regulatory burden).
- Valuation at peak 23x versus 16.6x historical average and above historical premium (1.3x versus 1.2x average).
- Seems fairly valued given potential positive tailwinds and compelling mid-teens EPS growth also reflected in peak valuation.
- Then: $100.29
- Now: $119.58
- Return: 19.23%
- TR: 19.23%
TOTAL RETURN AVERAGE: 13.80%