May 14, 2019

Mike Newton's Top Picks: May 14, 2019

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Full episode: Market Call Tonight for Tuesday, May 14, 2019

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Mike Newton, director and portfolio manager at Scotia Wealth Management
Focus: North American large caps and ETFs

MARKET OUTLOOK

At the start of the Q1 earnings season, analysts had expected earnings growth to turn negative. But with nearly 83 per cent of S&P 500 companies having reported revenues and earnings for the quarter, earnings continue to beat forecasts and growth is trending net positive. As they often have done in the past, industry analysts were too aggressive in cutting their numbers going into the latest earnings season.

At the worst of it during the week of April 12, analysts had S&P first-quarter earnings expectations down for 2019 by as much as 2.5 per cent year-over-year. A few weeks later, the blended figure including reported results and estimates for yet-to-be-reported results saw comparisons up 1.8 per cent year-over-year. It appears that equity markets were in the midst of an earnings trough. Contributing to the problem are last year’s U.S. tax cuts, which have made for difficult year-over-year comparisons.

We expect earnings growth to resume, supporting equity market performance. Near-term, trade-related volatility will reassert itself in markets. I expect equities to remain volatile, but only temporarily. Equity risk premiums will likely rise, and long-term government bond yields will likely decline as investors hedge risk assets and ratchet down their growth and inflation expectations. While this latest trade flare-up may impinge on global growth, we don’t expect it to tip the economy into recession, particularly in light of central bank data-dependence and fiscal stimulus measures adopted by several countries, including China.

TOP PICKS

Mike Newton's Top Picks

Mike Newton of Scotia Wealth shares his top picks: Comcast, Alibaba and Franco-Nevada.

COMCAST (CMCSA.O)
Recently purchased at $42.89 on April 25, 2019.

Comcast is a telecommunications and media conglomerate. Its cable, NBCUniversal and Sky segments represent 50, 32 and 18 per cent of revenues respectively. Comcast benefits from the scale advantages associated with being the largest cable broadband service provider in the U.S. We believe there’s still a long runway for subscriber and average revenue per user growth within Comcast’s broadband connectivity business. It’s broadband speed and capacity advantages relative to alternatives should support pricing power.

While the company is losing cable subscribers as consumers cut the cord, it’s also winning over more internet customers in need of high-speed connections to fuel their entertainment binge, with its customers' monthly Internet data usage increasing 34 per cent year-over-year in the first quarter. Comcast cashes in on increased streaming video usage because of its 1-terabyte cap, charging $10 fees for each additional block of 50 gigabytes or $50 monthly for an upgrade to unlimited data.

Comcast also agreed to sell its 33-per-cent stake in Hulu to Disney. Per the agreement, Comcast can sell the company at a valuation of either a minimum of $5.8 billion or whatever Hulu is worth in five years. Disney also agreed to pay Comcast for its Hulu content for those five years. Currently, Comcast receives $500 million per year for its content.

ALIBABA (BABA.N)
Recently purchased at $186.62 on May 6, 2019.

Chinese stocks have plunged sharply as investors worried that additional U.S. tariffs might negatively affect the country’s slowing economy and companies. E-commerce giant Alibaba has seen its shares fall more than 12 per cent from a year ago. We’re taking advantage of this decline to re-enter a position that we owned many months ago.

Alibaba offers a direct play on the rise of China’s middle class, which is one of the most incredible phenomena in economic history. Alibaba is the world’s largest e-commerce company as measured by gross merchandise volume. Beyond e-commerce, the company has also built a superior ecosystem.

Since most inverses are familiar with the company, I thought I would highlight an interesting business line. One of the backers of this year’s best picture Academy Award winner Green Book is Alibaba Pictures. Alibaba Pictures hopes to leverage the company’s edge in big-data technology and e-commerce and enhance cooperation with other Alibaba digital media and entertainment businesses in the same way Netflix creates some of its programming.

FRANCO-NEVADA (FNV.TO)
Recently purchased on Feb. 11, 2019.

As a royalty streaming company, Franco-Nevada business model has several attractive features: It’s not exposed to uncertainty related to mine site costs; its cash operating margins are much higher and steadier than operating companies and hence it’s able to generate strong cash flow and pay increasing dividends throughout the commodity cycle; it’s very scalable (with low overhead) and hence it’s been able to develop a diversified portfolio; exploration upside on its land positions gives it a positively asymmetric risk profile since it generally doesn’t need to contribute additional capital (beyond its initial investment) to fund further exploration and development; and it has a naturally contrarian tilt because operators are generally more likely to seek royalty and stream financing in commodity bear markets, when other sources of capital are not typically available.

Franco-Nevada has a very strong and growing portfolio that includes many large positions in tier-1 assets that have low costs and long mine lives. Management expects its annual production rate to grow substantially over the next several years, in particular as Cobre Panama comes on-line. The company’s investment approach includes many smaller royalty investments in exploration assets, which provides significant optionality and its oil-and-gas segment provides some additional portfolio diversification.