John Zechner's Top Picks
FOCUS: North American large cap stocks
After stocks have more than doubled from 2020 lows with only two minor pullbacks, valuations at record highs and speculation rampant in many asset classes, it should come as no surprise that the market has been at risk for a correction. The worries about the growing spread of the Delta variant of COVID, some more hawkish chatter from U.S. Fed governors, further weakness in the Chinese and European economic data and current geo-political risk in the Mideast seem to be heightening all these fears during the typical period of slower summer trading activity.
While the S&P 500 is only down 2 per cent from its recent all-time high, the damage to the economic cyclical sectors has been much more severe in the past few months as fears about the ending of stimulus payments and risks about the re-opening have damaged the outlook for many commodity and ‘value-oriented’ sectors.
Strength in the large technology stocks in the U.S. (over 30 per cent of the index) and the banks in Canada have lessened the impact on the major averages, but the more broadly based and domestic Russell2000 Index in the U.S. is now down over 10 per cent from its May peak while the energy sector in Canada has absorbed the bulk of the selling here, dropping over 20 per cent from its June high.
After raising some cash in May-June we are looking to add back to stocks on the current weakness. While the spread of Delta is leading to some sharp weakness in global economic data (Citi Economic Surprise Index, retail sales, consumer sentiment) we still believe we are early in the recovery cycle that began last spring. The initial surge in growth is giving way to a more modest expansion and that downshift typically leads to more volatile markets. But most of the slowdown issues we see are related to supply constraints as opposed to demand slowdowns. As these bottlenecks clear, we expect that this cycle could be prolonged, particularly since the fiscal and monetary supports are expected to remain in place for some time.
While technology and health care will be the key growth sectors over the longer term, we are seeing opportunities in the space segment, renewable energy and the auto/parts sectors for their penetration into electric vehicles and autonomous driving. We are also adding back to energy stocks. While the very long term outlook for this sector is not bullish, the stocks are not even close to reflecting oil prices in the US$60 range and stronger natural gas prices. We have also added to the gold stocks. Valuations are at multi-decade lows and the massive expansion of the global money supply and negative real interest rates will provide a tailwind for real assets in fixed supply such as gold.
Martinrea International (MRE TSX)
Latest purchase $12.00 – August 2021
This stock is at exceptionally low valuation but has been hurt by the recent global chip shortage and its impact on auto production. They have a strong balance sheet and generate positive free cash flow and should see a significant recovery in growth as auto production ramps back up. It has a focus on the ‘lightweighting’ of vehicles through greater use of aluminum parts, a key factor in meeting the growing demand for electric vehicles. MRE had the added benefit of an investment in VoltaXplore, which gives it EV battery exposure. The heavily-discounted valuation provides an opportunity much like it did at market lows in 2009 and 2016. Insiders at the company have also been active buyers of the stock recently, another endorsement of the attractive valuation and growth.
Arc Resources (ARX TSX)
Latest purchase $7.65, August 2021
Arc is extremely undervalued given current oil and gas prices, with a pristine balance sheet and ample growth properties following its purchase of Seven Generations Energy, which continues to consolidate producers in the natural gas-rich Montney region of British Columbia and Alberta. The combined company is now Canada’s largest condensate producer and third-largest natural gas producer. Other benefits from the deal include cost savings, capital allocation opportunities and the larger size of the company being advantageous when dealing with marketing partners and accessing capital markets. The merger between ARC and Seven Generations gives the scale both companies needed to be more institutionally relevant with global investors.
MDA Ltd (MDA TSX)
Latest purchase $15.50 – August 2021
MDA returned to the public market this year as the former MacDonald Dettwiler was sold by Maxar to private equity in 2019. A global leader in orbital robotics and satellite infrastructure/subsystems, it is generating positive free cash flow, has a strong balance sheet and trades at an attractive valuation. Opportunity exists in the low-Earth orbit satellite constellations driven by the demand for internet communications as governments act to improve internet access. A very strong balance sheet will support capital spending as it rolls out new programs. Recent results beat expectations with growth in GeoIntelligence and Satellite Systems. MDA projects annual revenue growth of over 25 per cent over the next five years as several key ‘flagship programs’ roll out.
PAST PICKS: October 13, 2020
Rogers Communications (RCI/B TSX)
- Then: $54.11
- Now: $63.70
- Return: 18%
- Total Return: 21%
Martinrea International (MRE TSX)
- Then: $10.53
- Now: $11.78
- Return: 12%
- Total Return: 13%
Enbridge (ENB TSX)
- Then: $38.96
- Now: $48.55
- Return: 25%
- Total Return: 33%
Total Return Average: 22%