Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American Equities

MARKET OUTLOOK:

Economic gravity has made its presence felt in the North American stock market these past two months after a red hot first seven months of the year, notably in the technology and consumer discretionary sectors of the markets.  The “last mile” in central bankers’ fight with inflation, however, is proving to be tougher than many had anticipated, and accordingly, despite the epic extent and pace of interest rate increases over the past 18 months, a hawkish policy and stance continues to prevail at both the Bank of Canada and the U.S. Federal Reserve, whom we heard from last week.  Our portfolios remain conservatively positioned, with a primary emphasis on well-capitalized, high-quality businesses rather than credit-dependent, or deeply cyclical companies.  We selectively added energy exposure to portfolios earlier this month, while taking profits on some of our Canadian consumer staples companies.  We also made several within sector switches recently – trading “better” for “best-in-class”, in both instances.  When the opportunity is afforded to us to buy trophy companies on sale, as it is, considering the six and eight per cent pullback in Canadian and U.S. market indices from their late July peaks – we seize upon it enthusiastically.

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TOP PICKS

The Hershey Company (HSY NYSE)

Latest purchase Sept. 2023 at $212.73: Hershey is the largest chocolate producer in North America, with a 45 per cent market share across well known brands like Kisses, Reeses, Twizzlers, Kit Kat, Brookside and Almond Joy among others.  Hershey has a smaller but fast growing salty snacks business with brands like Dots Pretzels and Skinny Pop popcorn as well as a small international business selling into developed and emerging markets.  Hershey earns best-in-class margins 10 points above its peer group average and leads all of its peers in profitability with a 26 per cent return on invested capital and is also the best rated consumer packaged goods company on ESG (environmental/social/governance) metrics.  The stock has corrected 26 per cent off the May peak, affording an excellent entry point with the shares trading at 20x earnings – well below the five year average multiple of 24 times.

Linde PLC (LIN NYSE)

Latest purchase Feb. 2022 at $309.03: Linde is the largest industrial gas company in the world selling hydrogen, oxygen, nitrogen and carbon dioxide to end markets in manufacturing, chemicals, energy, healthcare, metals, electronics and food/beverages.  Consolidation in the industry has resulted in a few large, price rational players and Linde in particular primarily strikes long term take-or-pay contracts with full cost pass throughs and accordingly has good pricing power.  The company and its predecessor, Praxair, have at least a three decade unbroken streak of annual dividend increases, supported by its strong competitive position within its consolidated industry and by its exposure to both defensive and growth end markets.  The shares trade at 25 times earnings – in line with long run average multiples and at its typical slight, but well deserved premium to peers.

Bank of Montreal (BMO TSX)

Latest purchase Dec. 2022 at $123.84: Bank of Montreal is Canada’s third largest bank and post the recent acquisition of Bank of the West is one of the 10 largest banks in the United States as well, operating in 32 states. The bank’s strong suit on both sides of the border is in commercial banking and lending.  A large Canadian wealth management business, a large North American capital markets business and a small insurance business round out the deposit and lending franchises nicely.  The Bank of the West deal is expected to bring in at least US$670m in synergies by mid year next year and some personnel and real estate efficiencies across all lines of business have been identified targeting another $1 billion in cost savings.  With a 13 per cent return on shareholders equity and a seven per cent compound growth rate in dividends over the last decade, the shares offer a compelling combination of current income with today’s 5.2 per cent yield and steady future growth.

PAST PICKS: December 15, 2022

Microsoft (MSFT NASD)

Then: US$249.01
Now: US$309.94
Return: 24%
Total Return: 25%

Royal Bank of Canada (RY TSX)

Then: $128.22
Now: $118.08
Return: -8%
Total Return: -5%

CVS Health (CVS NYSE)

Then: US$97.60
Now: US$70.53
Return: -28%
Total Return: -26%

Total Return Average: -2%