May 2, 2018

John Zechner's Top Picks: May 2, 2018

BNN Bloomberg

Zechner , BNN Bloomberg

John Zechner, chairman and founder of J. Zechner Associates
Focus: North American large caps

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MARKET OUTLOOK

We understand the bullish case for the stock market. Continued economic buoyancy, exceptionally strong earnings reporting season and a recent reduction in excess stock valuations could set up the market for a retest of the January highs and a continuation of 2017’s. But we see the headwinds: early signs of slower global growth, continually rising interest rates and a potential peak in earnings growth in 2018 have all combined to put in a larger rollover in stock prices. We may have already seen the peak.

The volatility seen since early February is a warning shot that the period of complacency for stocks is over with. We’re very late in the economic cycle, with wage and inflationary pressures starting to rise and capacity constraints in labour markets squeezing corporate profits. The ‘near zero’ interest rate environment had been the reason for both the expansion in stock valuations and the massive increase in corporate borrowings to fund stock buybacks in the past five years. Now, that stimulus is being withdrawn.

Risk in markets remains at an elevated level. Within our managed portfolios, we’ve increased slightly our exposure to short-term bonds as a hedge against potentially slower economic growth and overall more attractive yields than seen over the past few years. We’ve taken some profits in preferred shares after a very strong two-year run in that group. We still have a slight overweight in preferred shares, though, due to the very attractive gross dividend yields. Stock weights remain below average levels as we have recently reduced positions in U.S financial and technology stocks as well as some Canadian energy stocks, which had strong gains in the March-April period. The recent gains in the U.S. dollar also prompted us to reduce gold stock weights for now as gold prices have failed on three occasions to break through the critical US$1350 range. We also continue to expect a volatile year in 2018 and are holding higher cash levels to have the liquidity to trade any opportunities as they arise.

TOP PICKS

MAXAR TECHNOLOGIES (MAXR.TO)
Most recent purchase at $58 on March, 2018.

With the closing of its DigitalGlobe (DGI) acquisition, Maxar is set for new round of growth at a valuation discount to aerospace peers. DGI provides Maxar with increased exposure to the data and services part of the satellite earth observation market, which has higher growth than their traditional satellite manufacturing business. It also gives them better U.S. market access and therefore more exposure to growing U.S. government spending in this area. Strong free cash flow generation will allow them to pay down acquisition debt relatively quickly. The valuation is reasonable at about 10 times forward earnings and 8 times forward enterprise value to earnings before interest, taxes, depreciation and amortization (EV/EBITDA). We should also see increased interest from U.S. investors.

ALPHABET ‘C’ SHARES (GOOG.O)
Last purchase at US$920 on August, 2017.

Alphabet remains the top choice in large-cap technology as they dominate in the key growth areas of search and online advertising.

The company continues to produce impressive financial performance, with growth exceeding 20 per cent for 32 consecutive quarters and accelerating versus prior quarters. Alphabet is seeing improved and strengthening prospects from mobile and YouTube advertising, as well as increased traction in the company’s cloud business. On top of this, they own the (not yet monetized) Android operating system, which supports over 60 per cent of global wireless devices. Alphabet also has other growth initiatives underway, ranging from Nest and the Pixel smartphone, to the company’s autonomous vehicle unit Waymo.

The fundamentals behind the numbers remain as strong as ever from a qualitative perspective. Large cash generation also gives the company liquidity to expand further. Valuation is exceptionally low given its growth profile and offers attractive upside at the current price.

QUALCOMM (QCOM.O)
Most recent purchase at US$50 on April 2018.

We see upside earnings potential from multiple sources as the leader in the telecommunications industry readies for a global wave of spending on the 5G rollout. While the Broadcomm bid of US$82 per share has been withdrawn, we see earnings upside from the NXP Semi acquisition. There are also currently no earnings from various parts of their QTL business, as Chinese manufacturers hold back royalty payments and disputes with Apple continue. Any resolution of either issue would lead to earnings upside. Qualcomm also remains positioned as undisputed leader in the smartphone market for further gains as the world moves to 5G. The stock is trading at only about 15 times next year’s earnings even assuming none of these issues are resolved.