Brian Madden's Top Picks: Oct. 24, 2018

Brian Madden, senior vice-president and portfolio manager at Goodreid Investment Counsel
Focus: Canadian equities

MARKET OUTLOOK

Assessing current economic circumstances, we’d be hard-pressed to describe the economy as anything other than "Goldilocks," that is to say, neither too hot nor too cold. Job creation has been extremely robust and accordingly unemployment at 5.9 per cent is within a single tick of the lowest level in recorded statistics going back to the mid-1970s. Yet, core inflation remains well contained in the middle of the Bank of Canada guideposts of 1 to 3 per cent. Like the Fed, the Bank of Canada is using this Goldilocks backdrop as license to move slowly away from the “emergency” rock-bottom levels of interest rates that have prevailed throughout the last decade. Rising interest rates will often depress the price-to-earnings multiples investors are willing to pay per dollar of corporate earnings, as bonds become relatively more attractive against stocks and spawn a substitution effect as investors re-evaluate their overall asset allocations. Markets also begin to discount a slowdown in earnings over the medium term as tighter money restrains corporate expansion and hiring plans, and discourages big-ticket consumer purchases. Canadian stocks accordingly are showing signs of moving into a late-cycle phase wherein the leadership baton is passed from pro-cyclical segments of the market like energy, materials, consumer discretionary and technology companies to more defensive businesses in the real estate, utilities, telecom and consumer staples sectors.

As always, our research efforts are “bottom-up,” focusing on known shareholder value drivers like earnings growth, profit margins, management quality, sustainable competitive advantage and valuations. But we manage the overall portfolios holistically and have sought to introduce fundamentally strong companies with lower economic cyclicality and lower stock market betas, or sensitivity to movements in the overall markets. Our recent sales of high-beta technology and industrial companies have funded purchases of new lower beta investments in real estate, utilities and in consumer staples, for instance. A corollary of this repositioning has been a modest uptick in the expected dividend yield of our portfolio, which has been an important element of investors’ overall return year-to-date, and which we expect to continue to play an important role. Higher yielding portfolios increase the “certain” income component of total return and lower beta portfolios de-risk the variability in the “uncertain” capital appreciation component of total return. We believe this is the prudent stance to take at this juncture in symmetric, but opposite fashion to the stance we took in mid-2016 to increase portfolio beta and decrease yield as economic growth accelerated.

TOP PICKS

FORTIS (FTS.TO)
Latest purchase: October 2018 at $41.85.

Fortis has grown mightily from its humble roots as Newfoundland Light & Power Company to become Canada’s largest utility, with ownership of 10 locally operated gas and electric utilities across Canada, the U.S. and the Caribbean. 97 per cent of its assets are rate-regulated, which ensures shareholders recoup the full costs of doing business as well as a competitive return on their invested capital regardless of changing business conditions or commodity prices. The shares offer a dividend yield of 4.3 per cent, and that dividend has been increased for 45 consecutive years in a row. Plans to sustain a 6 per cent compound growth rate in the dividend over the next five years are well supported by the company’s robust $17.3 billion slate of capital expansion projects.

MANULIFE (MFC.TO)
Latest purchase: October 2018 at $23.28.

Manulife is Canada’s largest life insurance company. The business is well balanced geographically, with roughly one-third of revenues coming from each of Canada, the U.S. and Asia. The stock yields 4.2 per cent and trades at one-time book value, which is discounted both against other Canadian life insurers and relative to its long-term average trading multiples. Manulife offers a 12.5 per cent and rising return on shareholders’ equity. A high profile lawsuit of dubious merit involving a 20-year old insurance policy has recently created a very compelling entry point in the share price.

NORTH WEST COMPANY (NWC.TO)
Latest purchase: October 2018 at $27.95.

North West Company retails necessities like food, apparel and general merchandise across a network of 238 stores under various banners including Northern, Cost-U-Less, AC Value and Giant Tiger in remote communities in the Canadian north, in Alaska, in the South Pacific and in the Caribbean. Due to long supply chains and complex logistics, most of the markets the company serves are immune from the competitive threat of e-commerce, and moreover, many of their stores are in communities so small as to be natural local monopolies. Accordingly, the company earns net margins and returns on shareholders’ equity well above other grocers and general merchants. With the shares trading at 14-times expected earnings, which are temporarily depressed as they rebuild and reopen several stores damaged by hurricanes last year, the valuation of the company is very compelling in light of its durable competitive advantage and high visibility growth prospects that are largely independent of outside economic forces and cycles.

PAST PICKS: OCT. 18, 2017

ENBRIDGE (ENB.TO)

• Then: $50.42
• Now: $41.17
• Return: -18%
• Total return: -13%

SCOTIABANK (BNS.TO)

• Then: $80.65
• Now: $69.21
• Return: -14%
• Total return: -10%

CGI GROUP (GIBa.TO)

• Then: $66.78
• Now: $78.18
• Return: 17%
• Total return: 17%

Total return average: -2%

FUND PROFILE

Goodreid North American Balanced

Goodreid’s balanced approach allows investors to participate in the potential growth of equity holdings while mitigating risk through ownership of quality fixed income instruments.

Performance as of: Sep. 30, 2018

• 1 year: 8.5% fund, 3.7% index
• 3 years: 9.0% fund, 6.0% index
• 5 years: 9.4% fund, 5.8% index

Figures included reinvested income and are net of fees.
Index: Globe Canadian Equity Balanced Peer Index Average.

TOP HOLDINGS AND WEIGHTINGS

1. Canadian equities: 31%
2. U.S. equities: 40%
3. Canadian fixed income: 18%
4. Cash: 11%

 WEBSITE: http://www.goodreid.com