Feb 12, 2019

Mike Newton's Top Picks: Feb. 12, 2019

BNN Bloomberg

Mike Newton , BNN Bloomberg

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

MARKET OUTLOOK

In 2008, markets corrected due to things we weren’t talking about. Now, markets have corrected due to things we’re talking about. Stocks can always fall further before they put in a durable bottom, but it’s worth noting that only the deep recessions of the 1940s, early 1980s and 2008-2009 resulted in stocks spending many years below water. Barring a truly global recession, I think it’s unlikely that stocks will test new lows anytime soon. Since 1926, this has only occurred five times and only once since World War II. Despite what the media will say, horrific bear markets are exceedingly rare.

I view the current market correction as more of an opportunity for the bulls than the bears. The market has priced in a significant amount of future “bad news” to come in 2019 and valuations have become quite undemanding. My takeaway from the recent market action is that the current rally has undone or corrected a healthy portion of the overall decline in response to decreased worries over the Fed and trade. Going forward it’s valid to price in slowing growth, but unreasonable to be more negative than that. As always, new trends will emerge to replace old ones and one must adjust accordingly.

TOP PICKS

SUMMIT INDUSTRIAL REIT (SMU_u.TO)
Most recent purchase at $9.97 on Jan. 10.

Summit Industrial is involved in the commercial leasing of real estate property with property locations across Canada. It’s focused on the light industrial sector of the Canadian real estate industry. These are used for warehousing and storage, light assembly and shipping, call centres, technical support and the like. It has a dividend yield of 5.7 per cent.

Rising credit spreads emerged as a headwind for REITs as financial conditions tightened on the back of a hawkish Fed. Wider spreads may have had some investors concerned about the ability of REITs to refinance their debt at acceptable rates. After treading water since the end of 2013, Summit Industrial began a steady climb in the second half of 2016. The REIT continues to set new 52-week highs on a regular basis. Unlike broad market averages which have been trending lower, Summit Industrial's 200-day moving average continues to trend upwards.

TRANSDIGM GROUP (TDG.N)
Most recent purchase at $427 on Feb. 11.

TransDigm is a designer, producer and supplier of engineered aircraft components for use on commercial and military aircraft in service. They operate in three segments: power and control, airframe and non-aviation. Its product offerings include mechanical and electro-mechanical actuators and controls, engineered latching and locking devices, and seatbelts and safety restraints.

Recently, TransDigm reported some very positive news: a guidance raise, robust organic growth and superb margin performance. Sales grew 17 per cent year-over-year (YOY) and 12 per cent organically as double-digit growth in defence and commercial original equipment manufacturing well outpaced expectations and aftermarket activity remained in the mid-single digits despite concerns of slowing traffic. 20 per cent booking growth in the quarter suggests further momentum. Meanwhile, margins increased 250 basis points YOY.

REALTY INCOME (O.N)
Most recent purchase at $68.68 on Dec. 5.

Realty Income calls itself the "The Monthly Dividend Company.” For 49 years, investors have enjoyed monthly dividends which have steadily increased over time. The dividend of 3.75 per cent is supported by over 5,600 freestanding commercial properties that generate rental revenue from long-term net lease agreements.

Realty Income is one of the highest-quality net lease portfolios among U.S. REITs. In the field of commercial real estate, a net lease requires the tenant to pay, some or all of the property expenses that normally would be paid by the property owner in addition to rent. An attractive cost of capital will likely continue to fuel accretive acquisitions, leading to 4 per cent annual adjusted funds from operations (AFFO) per share and dividend growth in 2019 and 2020 estimates.

The company also has limited exposure to retail bankruptcy impact based on tenant analysis: 60 per cent of tenants are considered to be in healthy industries, 28 per cent in stable industries and 11 per cent in risky industries. Realty Income has limited exposure to the categories where there may be more risk like book stores, office supplies and pet supplies. Of 43 retailer bankruptcies since 2017, Realty Income has had less than 1 per cent rent exposure. The company is expected to pursue acquisitions of $1.75 billion in 2019 and $1.9 billion in 2020.