Lyle Stein's Top Picks: July 5, 2018

Lyle Stein, senior portfolio manager and managing director at Vestcap Investment Management
Focus: Canadian equities

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MARKET OUTLOOK

PLAYING DEFENSE — THE GAME GETS TOUGHER

As the World Cup marches to an end, it's been interesting how the teams have increasingly played “not to lose.” As markets head into the second half of 2018, our inclination is to play a similarly defensive game when it comes to managing client portfolios.

Equity markets have had a lacklustre first half. While energy stocks help Canada hit a new all-time high in June, our market continues to underperform the broader U.S. markets, a problem exacerbated by the declining loonie.

While we view Canada as cheaper than the U.S., the headwinds facing the domestic market are increasingly formidable. First is the housing slowdown, which was caused by higher interest rates and ill-timed policy moves to deliberately slow our biggest growth engine. Second, our leverage to higher oil prices has been severely dampened by the limited takeaway capacity of our largest single export product. Third, and the biggest risk, is a full breakdown in the NAFTA discussions. Finally, with provincial deficits rising everywhere but Quebec, the ability of the country to withstand a downturn is limited. Our ultimate fear is a "made-in-Canada” recession.

Going into the second half of the year, we continue to hold above-average cash positions. As long-term investors, we want to have dry powder available to purchase good companies that temporarily go on sale when earnings momentum disappoints. In the current market environment, this is a truly contrarian approach. We have limited exposure to fixed-income securities, with preferred shares being the investment of choice.

Preferred shares continue to offer high yields (especially for taxable investors), and some prospect for inflation protection. Our equity strategy continues to emphasize financials (for their dividends) and selected technology names which are chosen on the basis of value, not momentum. We increased U.S. equity exposure during the quarter, and look to buy more U.S. names in the future.

TOP PICKS

TECK RESOURCES (TECKb.TO)

Materials stocks are the cheapest they've been in years and Teck provides diversified exposure to four key commodities: met coal, copper, zinc and, most recently, oil. Its balance sheet has been repaired and cash continues to pour in. We expect to see further dividend increases going forward, regular and special. The market is too focused on commodity gyrations and not the long-term value of assets.

PRAIRIESKY (PSK.TO)

A unique play on the oil patch resulting from its royalty structure (no operating leverage to oil prices), the stock has recently fallen on hard times after disappointing the Street with lighter than expected first-quarter production. It has no debt on the balance sheet, an undervalued land base, a simple business model and a growing 3 per cent dividend, with extensive drilling opportunities down. PrairieSky is a great “hard-asset” play.

FEDEX (FDX.N)

A great name with which to diversify out of Canada. The recent sell-off on trade worries has created a buying opportunity in this global franchise. Despite the progress of e-commerce, online sales still represent only 10 per centof total retail sales and continue to grow at high single digits. In mid-August, the US Postal Service is expected to raise prices after Trump’s task force reports its recommendations. FedEx and UPS are likely to follow, serving to boost future revenue. While UPS is unionized, FedEx lacks this characteristic. By 2021, capex will drop substantially once the company has completed its investment in a new fleet of planes. Trades at 14 times earnings, with potential for double-digit growth going into the 2019-2020 period. 

PAST PICKS: MAY 9, 2017

HUDBAY MINERALS (HBM.TO)

• Then: $7.70
• Now: $7.01
• Return: -9%
• Total return: -9%

SUNCOR ENERGY (SU.TO)

• Then: $43.12
• Now: $53.87
• Return: 25%
• Total return: 30%

STARBUCKS (SBUX.O)

• Then: $60.98
• Now: $48.44
• Return: -21%
• Total return: -19%

Total return average: 0.67%

WEBSITE: http://www.vestcap.com/