May 31, 2018

John O'Connell's Top Picks: May 31, 2018

BNN Bloomberg

John O'Connell , BNN Bloomberg

John O'Connell, chairman and CEO of Davis Rea
Focus: North American large caps

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MARKET OUTLOOK

Markets have been strong over the last month, rallying off the lows that we experienced in February. There has been lots of variability in the results, but corrections are a normal part of the investing process. The key difference in the most recent correction was that interest rates were also rising. Bear markets are traditionally defined as declines greater than 20 per cent, usually associated with recessions, financial crises, and major wars. Economies are growing with employment and wage growth remaining strong and companies continuing to show positive earnings momentum, albeit at a slower rate. We had an economic and corporate earnings slowdown in 2014 to 2016, followed by a surge in growth in 2016-2017, and now with growth now normalizing around a more sustainable level. We still see a few risks to the market in the form of geopolitics, international trade and interest rates. Geopolitics are a hot topic with the Middle East heating up, which could cause a spike in oil prices, and with the current political situation in Italy roiling the market. International trade policy is also a risk as discussions around NAFTA continue to progress. The market is pricing in two to three more rate hikes in Canada and the U.S. this year, and the risk could be that we get fewer rate hikes than expected. Overall, the outlook for equities for the next three to six months looks positive, as recent weakness has incorporated some of these risks.

TOP PICKS

GOLDMAN SACHS (GS.N)

Goldman Sachs is one of the largest investment banks in the world. The bank has been using excess capital to return capital to shareholders both through dividend increases and share repurchases. The return of volatility has been helpful for Goldman as both their FICC (fixed income, currencies and commodities) and equities businesses reported stronger results last quarter. An additional data point that was reported earlier this year claimed that Goldman made $200 million of profit in one day’s trading activity. The bank has expanded its retail banking presence, with an online banking product called Marcus for savings accounts and personal loans, and has made inroads on building out its commercial banking business. Goldman will benefit from increased capital markets activity and increased M&A activity by corporations, but has also grown its investment management business to 20 per cent of revenue, which provides more stable, recurring revenue. From a valuation basis, Goldman is also trading at more attractive price-to-book and price-to-earnings multiples versus its other investment banking peers (discounts of 4 per cent and 13 per cent respectively).

KEYERA (KEY.TO)

Keyera Corp. is involved in natural gas gathering and processing as well as natural gas liquids processing, transportation, storage and marketing. Keyera has an excellent management team that has consistently delivered strong results over the years. The shares currently yield 4.77 per cent, with a payout ratio that is fairly low at 57 per cent year-to-date. The company is well capitalized, having shored up the balance sheet over the last couple of years, and has been slowly deploying capital into new projects in the U.S. They recently announced a crude oil storage and blending terminal development project in Cushing and purchased a logistics and liquids blending terminal in Tulsa. Despite these investments, the company still has capacity for further growth investments in Canada and the U.S. as evidenced by their recent announcement of the second phase of a gas processing plant in the Montney area.

BROOKFIELD INFRASTRUCTURE PARTNERS (BIP_u.TO)

Brookfield owns and operates infrastructure assets on a global basis. The company operates utilities transport (such as toll roads), energy facilities, and communications assets in North and South America, Australia and Europe. The company is very well regarded internationally as a prudent allocator of capital and a shrewd operator investing not only its capital, but its expertise in operating and streamlining companies businesses and enhancing their market share. The company has shown strong discipline in harvesting mature investments within its portfolio and reallocating resources to areas that are presently out of favor. The company has a strong track record of dividend increases and presently yields 5 per cent.