Full episode: Market Call Tonight for Monday, October 22, 2018
Ashley Misquitta, senior portfolio manager at Empire Life
Focus: U.S. equities
We continue to be cautiously optimistic in the near term, where we see meaningful positives but non-trivial risks. We’re only in the very early stages of seeing the secondary positive impacts of the tax reform bill. Beyond that, some very large U.S. companies are likely to continue 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 could see more 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. We expect these and other dynamics will be economic drivers and continue to help make the U.S. 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 our companies to get stronger in downturns and prosper in upturns, enabling us and our investors to benefit over time.
- We trimmed Apple as it had grown to a larger weight in the portfolio than we typically carry.
- We trimmed Lowe’s somewhat as the stock appreciated. We still hold positions in both in the portfolio.
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 customer 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 PCs and was fourth largest in 2017.
Financially, Apple is in outstanding shape. The company boasts greater than $125 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 our view.
APTIV PLC (APTV.N)
Aptiv is a global auto parts company. They’re positioned to benefit from the transition to autonomous driving and electric vehicles. At the same time, they’re also poised to do well in an environment where these changes happen more slowly than anticipated. Their competitive advantages are robust, positioning them well for the future. Beyond their role as a component and system supplier, Aptiv is also one of the leaders autonomous driving. They currently have a fleet of vehicles in a pilot program with Lyft in Las Vegas where customers are being driven in autonomous vehicles in a geo fenced region. Our assessment is that Aptiv is in the top-tier of auto and technology companies attempting to develop autonomous driving systems.
The stock has sold off somewhat on concerns about global auto sales and could experience further pressure should we see further deterioration in the auto cycle. The company, however, is solidly cash-generative, has modest leverage and no meaningful debt maturities until 2020. We believe it trades at an attractive valuation relative to its long-term opportunity.
Celgene is a leading biotechnology company with a focus on treating cancer and autoimmune diseases. The company has stumbled somewhat in the past year or so on a potentially earlier-than-expected loss of exclusivity on Revlimid, their lead product; a “refuse-to-file” letter for Ozanimod; an important pipeline product for the treatment of multiple sclerosis; and finally, a failed phase 3 trial for another important pipeline drug. The broad concern around drug pricing and reimbursement has also weighed on the stock.
As we look forward, things appear much better. Incremental data points suggest that there may be less of a risk of early loss of exclusivity on Revlimid, two important phase 3 trials were positively announced recently, the refiling of Ozanimod looks to be on track for Q1/19 and there are a number of important late-stage clinical trial readouts coming in the next 12 to 18 months. All of this is happening as the company continues to experience robust growth in revenue, earnings and free cash flow.
The rich pipeline and possible business development actions with cash generated prior to loss of exclusivity on Revlimid have the potential to offset some or all of the impact from the patent expiry in the 2020s. The stock is attractively valued in our view.
PAST PICKS: APRIL 17, 2018
- Then: $229.52
- Now: $275.73
- Return: 20%
- Total return: 21%
- Then: $86.16
- Now: $98.39
- Return: 14%
- Total return: 15%
- Then: $178.24
- Now: $220.65
- Return: 24%
- Total return: 25%
Total return average: 20%