Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

The long-awaited U.S. Federal Reserve pivot occurred last week at the last board meeting for 2023. The U.S. central bank has given what investors believe is a clear signal that it is done hiking overnight interest rates. The only question now is when the first interest rate cut will occur. We concur with this view, although we do think investors might be premature in pricing in interest rate cuts as soon as March in the U.S. We are finding more opportunities in the U.S. lately, with growth opportunities more plentiful in that market than in Canada.

The Canadian economy is facing a number of medium-term growth headwinds, from housing and interest rate sensitivity to commodity dependence to productivity malaise, just to name a few. A number of the global giants and secular growth themes well represented in the U.S. stock market remain very much in gear, despite increasing evidence of pressure on consumer and household spending, particularly in more discretionary categories. Our portfolios have measured exposure accordingly to a number of these companies and themes and also remain well-positioned in defensive and economically resilient sectors and companies on both sides of the border.

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TOP PICKS:

Franco Nevada Corp (FNV TSX)

Franco-Nevada is a resource royalty and investment company whose management team and founders pioneered the resource royalty concept forty years ago. The business model affords shareholders exposure to commodity prices via a royalty payment for each ounce produced but insulates them from the operating and capital cost overruns that are endemic to the mining industry. The business model also affords shareholders long term optionality on future discoveries on any of their royalty lands, across a portfolio of 431 royalties that is well diversified by commodity, by geography and by operator. 

Franco-Nevada has consistently and significantly outperformed its gold mining peer group, in eleven of the last fourteen years since its initial public offering, on the strength of this superior business model. The steep selloff in the shares over the past two months reflects the market effectively writing off its largest royalty on the Cobre Panama copper mine which was nationalized by the government of Panama. We expect that its royalty interest will be upheld in international arbitration. Although not imminent, this royalty which accounts for 22 per cent of its net asset value represents excellent upside optionality once Franco Nevada and operator First Quantum Minerals has its day in court.

McKesson Corp (MCK NYSE)

McKesson is the largest pharmaceutical drug distributor in the United States. Pharmacy distribution is an oligopoly in the U.S. with the top three players holding a combined 90 per cent market share. Distributors negotiate bulk purchases of drugs from manufacturers on behalf of pharmacies, hospitals, long-term care and other end-market clients and physically move drugs to warehouses and then onto retail stores and other primary care endpoints. McKesson earns a high return on shareholders' equity in this non-cyclical business with very sticky customer relationships. No major retailer has changed their drug distributor in over a decade. Its smaller medical and surgical equipment distribution and pharmacy technology solutions and consulting businesses are higher margin and faster-growing businesses. In Canada, the company owns the Rexall retail pharmacy chain. 

Dividends have grown every year for the last 25 years and over the last five years at a compound rate of 10 per cent. The chart is trending steadily upwards and the recent upward re-rating of the shares to roughly 15.5 times earnings brings it back in line with its long-term (30-year) average multiple of 14.6 times. This is a marked improvement from the depressed most recent five-year average of 11.2 times. The re-rating is well warranted in our view, in light of the 2021 decision to exit the weak European business, as well as by improving efficiency and faster inventory turns all driving improving returns on equity and cash generation.

Uber Technologies (UBER NYSE)

Uber is the global leader in ride-sharing with 131 million monthly active users. Beyond mobility, Uber has expanded into food delivery, freight and autonomous vehicles. It is also beta testing a task service offering in several markets and has launched a premium subscription service offering members priority pick-ups and deliveries as well as savings opportunities. Uber’s platform benefits from scalability and strong network effects, such that more connected riders and drivers make the platform more valuable for both parties. This creates high barriers to entry for competitors. Financial performance has turned the corner, with the company finally in the black in 2023 after years of growth and investment, and we expect profits to triple in 2024 and grow a further 73 per cent in 2025. Uber shares, on the surface, don’t appear cheap, but the company’s hyper-growth over the next two years warrants a premium and on 2025 expected profits, the shares trade at a reasonable multiple of 27 times earnings.

PAST PICKS: MARCH 23, 2023

Nuvei (NVEI TSX)

• Then: $57.70
• Now: $34.35
• Return: -40%
• Total Return: -40%

TD Bank (TD TSX)

• Then: $77.33
• Now: $84.42
• Return: 9%
• Total Return: 13%

Fortinet (FTNT NASD)

• Then: US$63.25
• Now: US$57.72
• Return: -9%
• Total Return: -9%

Total Return Average: -12%