Dec 11, 2018

Mike Newton's Top Picks: Dec. 11, 2018

BNN Bloomberg

Mike Newton , BNN Bloomberg

Mike Newton, director of wealth management and portfolio manager at Scotia Wealth Management
Focus: North American large caps and ETFs

MARKET OUTLOOK

Admit it: At this stage in the sell-off the negative market theories are starting to sound more plausible to you than the positive ones. Now you need patience, as even your strongest convictions will get test.

When capital markets change direction, they often go too far before finding the right balance; when they overshoot to the downside, you can find some real values. Trade wars and tariffs, credit ratings, global debt levels, our current stage in the business cycle, the age of the equity bull market, corporate earnings, emerging market contagion risks and, of course, technicals are just a handful of worries that we’ll undoubtedly be carrying into 2019. For the time being, emotion and pessimism are overtaking fundamental based decision making.

JPMorgan's Marko Kalonovic made the following comment, which I agree with: "To some extent, we trace the disconnect between negative sentiment and macroeconomic reality to the reinforcing feedback loop of real and fake negative news. If we add to this an increased number of algorithms that trade based on posts and headlines, the impact on price action and investor psychology can be significant."

I remain agnostic and am accepting of a range-bound market for the next few months. To get some clues as to market direction, pay close attention to the behaviour of the financial and transport stocks. They need to participate in, if not lead, any positive and sustainable rebound. Failure to do so could break what’s left of the markets’ internal energy.

There are plenty of clouds hovering over the outlook for global economies. U.S. corporate earnings will probably decelerate in 2019 as the “sugar rush” associated with corporate tax reform starts to fade. But even with corporate margins possibly peaking, I’m not ready to write off positive earnings growth in 2019. The de-risking we’ve seen this year may create some attractive opportunities for active investors.

In the Newton Group portfolios, we’re ready. Our cash levels remain elevated and currently sit between 45 and 60 per cent, depending upon the portfolio.

TOP PICKS

CISCO SYSTEMS (CSCO.O)
Most recent purchase at $47.68 on Dec. 6, 2018.

With the growing list of countries imposing a ban on Huawei from participating in global 5G deployment, Cisco could benefit by winning a greater share of contracts. The company is continuing its business transformation to deliver more software offerings and drive subscription revenues, as global data traffic is expected to grow at an annual rate of 26 per cent from 2017 to 2022.

With a strong balance sheet holding $17 billion in net cash or $3.70 per share, Cisco has $14 billion remaining in its the authorized stock repurchase plan, which could drive shareholder returns of 7 per cent over the next three quarters on top of an already healthy dividend yield of 2.8 per cent. China retaliating and banning U.S companies within the country is a risk, as Asia represents 16 per cent of Cisco’s total revenues with China likely representing the majority.

I remain constructive on the network equipment space given expectations for healthy growth in communication equipment demand. In addition to networking products, Cisco benefits from the industry’s growing demand for software-defined network solutions, cloud-managed solutions and network security products, warranting a premium valuation.

UNITEDHEALTH (UNH.N)
Most recent purchase at $266.14 on Dec. 6, 2018.

UnitedHealth is for-profit managed healthcare company based in Minnesota. It’s a defensive stock, has low leverage, still has earnings momentum and is one of the 30 Dow components. Shares are only off about 7.5 per cent, underscoring its defensive characteristics.

CEO John Rex has said he sees the company still in an "early stage" when it comes to growth potential despite total revenue approaching a run-rate of $250 billion next year. Today, it serves 52 million individuals globally through all major health benefits segments. Since 2010 they produced one of the strongest periods of growth for any healthcare company, growing organically by more than 8 million people.

In 2018, UnitedHealth expects to grow by an additional 2.2 million people. Beyond this year, it sees potential for sustained growth, particularly with expanding government programs. A tax on insurers, projected to collect more than $14 billion in revenue this year, was suspended for one year. It now is set to take effect in 2019.

Return on equity forQ3 reached nearly 26 per cent and the debt-to-total capital ratio was 38.9 per cent. They have repurchased $3.7 billion of stock year-to-date at approximately $233 per share and continue to apply capital to the businesses through M&A, venture investments and organic development.

The strong and diversified growth, disciplined cost management, and strategic use of capital are combining to produce another year of meaningful financial performance at unitedHealth. Shares currently yield 1.35 per cent.

ROOTS (ROOT.TO)
Most recent purchase at $3.40 on Dec. 6, 2018.

The recent earnings announcement sent Roots shares plummeting and analysts scrambling to downgrade the company on all fronts. I’m using this reset to highlight the business and to recommend a small speculative opening position in shares. Roots shares are in deep-value territory, with multiples implying no growth going forward.

Roots is in the early stages of leveraging recent transformational initiatives and executing on a refined growth strategy. As a brand, it embodies a strong Canadian identity that resonates well with consumers and has a broad demographic appeal, both in its domestic market and internationally. It has a light footprint in North America, with only 120 locations, with only three stores in the U.S. Given that Americans consumers shop the brand online, it sees good potential to develop there.

Roots has historically maintained a marketing investment of less than 2 per cent of sales. As a result, the brand has been driven primarily by word-of-mouth and unpaid support from celebrities and athletes. Roots aims to double its budget to 4 per cent of sales and invest more aggressively as it enters new markets. Recently, Shawn Mendes partnered with Roots to launch a limited-edition capsule collection ahead of his first stadium show in Toronto.

It is my understanding that Searchlight Capital Partners still owns owns 48 per cent of shares outstanding, Don Michael owns 12 per cent and public shareholders own 40 per cent. Be careful with entering these shares, as tax-loss selling will keep them under pressure until the New Year.