Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities 

MARKET OUTLOOK:

Half of U.S. companies have reported fourth-quarter earnings. For the overall S&P 500 Index, generally, profits have been coming in well above analyst expectations and collectively are managing to grow at a four-per-cent pace relative to the same quarter last year.

In Canada, relatively few companies (10 per cent) have reported fourth-quarter results thus far, but expectations are subdued, with analysts forecasting a collective decline of about six per cent in profits for the index members. For our part, we see divergent paths for the Canadian and U.S. economies, with U.S. macroeconomic data more resilient and thus the country more likely to avert a recession. Canada, on the other hand, faces a number of challenges including high household debt and the consumption headwinds households will face when mortgages renew at higher rates, coupled with greater dependence on commodities in a year where global economic growth (and thus commodity demand) is expected to slow. 

We are accordingly finding more new investment opportunities in the U.S. than in Canada, particularly in companies that are either moderately cyclical or are secular growth leaders (i.e. “trophy” businesses) running global or multinational businesses. We are particularly mindful of geopolitical risk this year, with two regional wars raging currently and elections scheduled in a number of major economies including the U.S. We are also mindful of the lagged effect of the 2022-23 interest rate hikes on households, businesses and lenders as the credit loss cycle invariably follows the interest rate cycle.

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TOP PICKS:

Tourmaline Oil (TOU TSX)

Tourmaline is Canada’s largest natural gas producer, producing 2.3 billion cubic feet per day from Montney, Peace River and Deep Basin fields and another 100,000 barrels of oil and natural gas liquids daily.  It is also the fourth-largest midstream Canadian natural gas processor. We expect the company to grow earnings by nearly 20 per cent this year. Warm winter weather has kept natural gas prices low, but the company’s scale, lean operating model and low-cost structure enable strong profitability through the commodity price cycle. The company has recently struck a 15-year contract with Cheniere Energy to liquefy natural gas at Cheniere LNG plants on the Gulf Coast and then export it to Asia where pricing can be 10 times higher.

 Also the soon-to-be complete $40 billion LNG Canada export terminal should support structurally stronger demand and higher prices for Western Canadian natural gas. Tourmaline strikes a nice balance between growth and capital discipline. It has production volumes growing at an 18 per cent compound rate over the past five years and a flexible dividend policy that returned $6.55 to shareholders last year – which equates to a 12 per cent yield on today’s share price. It is trading at 5.1 times cash flow, having pulled back 26 per cent from the November high, and we see good value as well as a timely entry point into the shares here. 

Home Depot (HD NYSE)

Home Depot is America’s dominant home improvement retailer, serving the “pro” and do-it-yourself markets. The company has undertaken an aggressive pursuit of “pro” clientele and the one-stop shopping proposition for complex multi-trade projects. We believe this taking share from their primary rival, as well as from lumber yards, millwork distributors, paint specialty retailers, and more.

Recently the company has expanded into adjacent and less cyclical end markets addressing the repair, maintenance and operations needs of multi-family residential landlords, the hospitality industry, healthcare centres, government and institutional markets, prisons and more. All told, the company sizes up an addressable market of $950 billion annually, underpinned by the $43 trillion stock of residential housing in the U.S., which wear and tear depreciates like clockwork, requiring repairs and renovation. 

Enhanced e-commerce and omnichannel capabilities are enablers of growth for Home Depot, complementing its knowledgeable expert sales floor staff in stores. The results have been a 16 per cent compound growth rate in earnings and dividends over the past decade and regular large share buybacks as supplemental capital returns to shareholders. It is trading at 16 per cent below its 2021 peak levels and at just under 23 times expected earnings. The shares are inexpensive relative to historical and prospective earnings growth.

Marsh & McLennan Companies (MMC NYSE)

Marsh & McLennan is the global leader in insurance and reinsurance brokerage and risk advisory work through its namesake Marsh and Guy Carpenter units, which comprise 60 per cent of revenues. The remainder of the business is comprised of various consulting companies, including the Mercer and Oliver Wyman businesses and more.  

“Hard” (i.e. rising policy premiums) markets in property and casualty insurance, reinsurance and health insurance advantages the company as the broker placing business with underwriters and taking a percentage as a sales commission. The consulting businesses are advantaged by strong global employment growth and thus more covered lives in group retirement and benefit plans as well as by a secular trend towards outsourced delegated investment solution arrangements undertaken by pension plan sponsors. 

Finally, the company relentlessly pursues improvement through efficiencies and improvements in the business mix organically and via acquisition. Operating margins have risen every single year since 2008 and by a cumulative 1,700 basis points which have quadrupled returns on equity from nine per cent to 38 per cent today. Dividends have grown at a compound rate of 11 per cent over the past decade and total shareholder returns have compounded at 18 per cent over the period.