May 31, 2017
Michael Simpson's Top Picks: May 31, 2017
Michael Simpson, senior vice president and senior portfolio manager at Sentry Investments
Focus: North American dividend stocks
As of May 26, 2017 Amazon is up 32.7 per cent, Facebook is up 32 per cent, Netflix is up 31 per cent and Alphabet is up 25 per cent. The so-called FANG stocks are leading the market higher in the U.S. They are large and liquid and are owned by many ETFs. The broader S&P 500 Index is up 8.8 per cent. According to Cornerstone Macro as of April 30, 2017, the S&P 500 was up 6.8 per cent while the S&P 500 Equal Weight Index was up 5.2 per cent. This wide divergence means there are still opportunities in the market, provided you dig a little and move past the 10 to 15 largest companies in the U.S market. In contrast, the S&P/TSX is up 1.88 per cent year-to-date as of May 26, 2017. The TSX Capped Energy Index is down -13.8 per cent and the S&P Capped Financial Index is up 0.34 per cent for the same time period. In the oil-and-gas sector, we favour natural gas over oil, but in the commodity space we always are more inclined to invest in low-cost operators and those companies with strong balance sheets.
The Home Capital saga has hung over the Canadian financial sector. Although the business model is totally different from the largest banks in Canada, investors are questioning the resiliency of the highly-indebted Canadian consumer and how much longer credit losses can stay low. To be clear, the issues that surround Home Capital are around access to capital and cost of funding. The company is being investigated by the Ontario Securities Commission for not properly disclosing that 45 mortgage brokers who the company deals with had been suspended for submitting false or altered documents. Home Capital is a small part of the overall mortgage market in Canada serving the alternative or non-prime market.
By focusing on companies with strong cash flows and rising dividends, and companies that are trading below the valuations of the major markets, serves two purposes. In the event of a correction, these companies, because of their valuation, will in our view decline less than the overall market. And overtime, if these companies continue to perform, sentiment will change and they could get a valuation lift.
With regards to the political front, the market will have to see some progress on tax and health care reform. This will be a test to see what can be accomplished in the first year of a new U.S. president. Internationally, we will be watching to see if growth in China picks up. Canada was built on trade and trades for the prosperity and well-being of its citizens. There are many trade irritants with the U.S. now. However, softwood lumber disputes have occurred since pre-Confederation. Since the last lumber dispute, Canadian forestry companies such as West Fraser and Interfor have purchased sawmills and other lumber assets in the U.S south.
Overall, despite the headlines we are still seeing good value in the market.
AutoZone is a specialty retailer of automotive replacement parts and accessories. The company offers and extensive product line for cars, sport-utility vehicles, vans and light trucks, including new and remanufactured products. AutoZone has stores in the U.S., Mexico and Brazil. Eighty-one per cent of revenue comes from retail stores, 16 per cent from the commercial segment and three per cent from e-commerce. AutoZone has declined on concerns of weaker car sales and the fact that Amazon may enter the space. AutoZone has many factors to counter the threat of Amazon; it has excellent client service with knowledgeable store employees, instructional videos, and disposes of used oil free of charge in an environmentally-safe manner. AutoZone trades at 13-times 2018 earnings and has a free cash flow yield of six per cent. It trades at a 3.5-times turn discount to competitors Advance and O’Reilly.
EVERTZ TECHNOLOGIES (ET.TO)
Evertz designs and manufactures video and audio infrastructure solutions for the television, telecom, professional AV and media industries. Evertz has no debt and over $60 million of cash on the balance sheet. Evertz has a ROE of 26 per cent and a return on invested capital of 21 per cent. Evertz’s products route distribute control and monitor video and audio signals throughout large broadcast telecom and government operations. They also deliver television over telecom networks and IPTV. ET trade at approximately 16-times 2018 earnings and 10.5-times EV/EBITDA. They have grown their dividend at a five-year rate of 29 per cent and have paid out special dividends.
Pfizer is the second-largest pharmaceutical company. Although Pfizer has some drugs coming off patent in 2019, they have a pipeline and the ability to make acquisitions with a strong balance sheet and $14.7 billion in cash. Pfizer has a four per cent dividend yield and has grown their dividend eight per cent over the last five years. PFE trades at 11.8-times 2018 earnings and 11.2-times EV/EBITDA. There could also be a further catalyst if Pfizer decides to sell their consumer business (products such as Advil, lip balm and Centrum vitamins).
PAST PICKS: MAY 4, 2016
K-BRO LINEN (KBL.TO)
- Then: $41.59
- Now: $38.96
- Return: -6.32%
- TR: -3.30%
- Then: $18.21
- Now: $23.67
- Return: +29.98%
- TR: +34.91%
- Then: $35.05
- Now: $39.52
- Return: +12.75%
- TR: +16.00%
TOTAL RETURN AVERAGE: +15.87%
FUND PROFILE: SENTRY DIVERSIFIED EQUITY FUND SERIES F
PERFORMANCE AS OF APRIL 30, 2017:
- 1 month: Fund* 1.7%, Index** 0.4%
- 1 year: Fund* 18.2%, Index** 14.9%
- 3 years: Fund* 8.8%, Index** 5.1%
- 5 years: Fund* 13.5%, Index** 8.1%
* Returns are net of fees
** Index: S&P/TSX Composite
AS OF APRIL 30, 2017:
- CVS Health Corporation
- Morneau Shepell Inc.
- AGT Food and Ingredients Inc.
- Linamar Corporation
- Interfor Coporation