Ashley Misquitta, senior portfolio manager at Empire Life
Focus: U.S. equities
We're cautiously optimistic in the near-term where we see some positives. The positive impact of the tax reform bill is still in its very early days. Beyond that, some very large U.S. companies are likely to bring back some money that's currently held overseas. This is all in the face of very positive sentiment data from large and small businesses. At the same time, the U.S. Federal Reserve is continuing to raise interest rates and reduce the size of the balance sheet, the yield curve continues to flatten and trade tensions are rising. In the coming months, investors should expect some strong rhetoric around trade and potential market volatility induced by these and other factors.
Looking beyond the short term however, I'm optimistic about the investment opportunities in the U.S. The U.S. is an extraordinary global innovation engine and home to a growing working age population. Meanwhile, hydraulic fracking and horizontal drilling has turned the U.S. into an oil and natural gas superpower. These and other dynamics will be economic drivers and continue to help make America a market with vast investment opportunities in the long term.
From a portfolio perspective, we continue to focus on owning attractively valued, well managed businesses with sustainable competitive advantages, secular tailwinds, solid balance sheets and robust free cash flow generation. We believe these attributes enable U.S. companies to get stronger in downturns and prosper in upturns, enabling us and our investors to benefit over time.
Anthem is very well positioned for the changing healthcare landscape in the U.S. Because it not only has scale at a national level, but also a local level, it's able to negotiate and engage effectively with all parts of the healthcare system from a position of strength to help lower overall healthcare costs. Anthem is the largest provider of commercial insurance, a leader in Medicaid management for the country and has a growing Medicare Advantage business, which boasts a tailwind from the large numbers of people reaching 65 years of age in the US.
Financially, Anthem is attractive structurally as they generate substantial free cash and require modest capital spending. The free cash flow creates optionality to return capital to shareholders or to make tuck-in acquisitions. Anthem is enjoying meaningful economic tailwinds from the organic growth in their business, inorganic growth from the acquisition of smaller Medicare Advantage players and from federal tax reform. One unique upside to their business is that a flawed PBM contract with Express Scripts is reaching the end of its term and Anthem is expected to obtain substantially reduced costs as it moves to bring more work inhouse. Anthem’s valuation is attractive and does not appear to adequately contemplate the expected upside to earnings in the coming years.
Apple makes iPhones, iPads, Mac computers and other peripherals. The company also has a growing business selling services, including a streaming music service and cloud storage. Apple’s ecosystem has proven highly sticky and consumers continue to give its products extremely high satisfaction ratings. Apple dominates profits in the smartphone industry and holds strong share in the tablet market and the watch market. Remarkably, Apple has been continuing to grow its market share in computers and was fourth in 2017.
Financially, Apple is in outstanding shape. The company boasts greater than $150 billion in net cash and generates greater than $50 billion in free cash flow each year. Operating margins are above 25 per cent. The company has been using its cash balance to aggressively return capital to shareholders through dividends and share repurchases. The strength of its free cash flow generation and very large cash hoard are great defensive characteristics in a business that can still post steady growth. Apple’s valuation has expanded in recent years, but remains undemanding in my view.
Lowe’s is one of two dominant players in the extremely attractive and highly functioning home improvement industry. A large part of its business is project-based, so less Amazon exposure since customers are buying many items in one order. They're still very price-competitive. Lowe’s has a meaningful and growing business with professional tradespeople who often have requirements that Amazon is typically not well suited to address. The company is in the early days of making potentially substantial operational improvements where it has been weaker than Home Depot, but represents potential margin expansion opportunities. The business is highly cash flow generative and return on invested capital is strong. We believe Lowe’s would still generate substantial free cash flow in a difficult economic environment. It has been aggressively buying back stock and has repurchased over 40 per cent of the outstanding shares over the past decade.