Sep 20, 2018

Mohsin Bashir's Top Picks: Sep. 20, 2018

BNN Bloomberg

Mohsin Bashir , BNN Bloomberg

Mohsin Bashir, chief operating officer at JM Fund Management Inc.
Focus: North American large caps

MARKET OUTLOOK

Markets are well into the late-stage of the business cycle, where we should expect a rotation in leadership from sectors leveraged to capital expenditures to inflationary sectors. But the world continues to be mired in protectionist policies and tariff turf wars, contributing to higher degrees of uncertainty and a lack of market breadth. This is keeping market leadership congested to only a few sectors as the cost of capital begins to ratchet higher and corporations become increasingly incentivized for U.S. capital investment. On a year-to-date basis, large-cap technology, Amazon and health care account for over 90 per cent of the S&P 500 ’s gains for 2018, so there is not very much dispersion around what’s lifting the market. While the S&P 500 enjoys over 8 per cent returns thanks to its 41 per cent weight in technology and healthcare sectors, the TSX Composite struggles to eke out any positive gains as heavily weighted energy and materials sectors continue to lag. Anecdotally, quarterly conference calls do have rumblings of rising raw input and labour costs, which are inflationary.

The U.S. market is favoured both at an institutional and retail investor level. U.S. economic relative strength is largely a function of the boost given to corporate earnings by virtue of significant tax cuts that are likely to remain in place for a long time. However, the benefits of such cuts will be transitory, and eventually the double-digit earnings growth rates seen recently would need to be cultivated organically rather than manufactured by macroeconomic policy in order to validate current price-to-earnings multiples of 16.8 times forward earnings.

That said, we believe there are pockets of attractive value and that being exposed to equities in a risk-adjusted manner is the best way to participate in this market. Focusing on high-quality earnings, market-share leadership, prudent leverage and sustainable cash flows should help navigate the mounting uncertainties.

TOP PICKS

FEDEX (FDX.N)
Most recent purchase on March 23 at $230.08.

FedEx is the world’s largest express transportation company, serving over 220 countries and territories. It operates through four main segments, where express and ground make up over 80 per cent of total revenues. Across business lines, trends in demand and pricing are positive and there are several levers for margins to grind higher, including the integration of TNT Express and growth in e-commerce, which is benefitting the ground segment along with the pilot project of opening 50 locations inside of Walmart stores. Expansion plans are to have 500 of these locations within the next two years. They also recently announced plans to expand U.S. ground operations to six days a week to meet growing e-commerce demand ahead of the busy holiday season. Greater emphasis on automation and efficiency will be drivers of margin expansion. With a fully funded pension, higher free-cash flows become available to deploy toward operational efficiencies and share buybacks. We see FedEx trading at 14.2 times price-to-earnings as an attractive risk/reward proposition to gain exposure to the largest integrated global transportation network with margin tailwinds.

FACEBOOK (FB.O)
Most recent purchase on Sep. 6 at $161.11.

There’s been no shortage of headlines for this company in 2018 given the Cambridge Analytica scandal and Facebook's market cap decline following one of the largest value drops ever in stock markets after their Q2 earnings were released. Facebook is one of the most prolific virtual real-estate providers in the world, with two of the best Internet properties: Facebook and Instagram. It allows small businesses to instantly tap into a customer pipeline on a scale unlike anyone else and is a highly functional platform for entrepreneurs, which are the real economic engines for growth. The company generates over $20 billion in earnings per year, produces return on equity of over 20 per cent and carries no debt. The stock currently trades at a near all-time low on a forward price-to-earnings basis at 23 times following sobered growth expectations for the balance of the year amid higher capital expenditures of $15B driven by network infrastructure and data center investments which should position Facebook well for long-term growth.

RICHARDS PACKAGING (RPI.TO)
Most recent purchase on March 29 at $31.08.

Richards has been manufacturing and distributing glass and plastic containers in a variety of shapes and sizes since 1912. It’s the leading packaging distributor in Canada and the third-largest in North America, offering one of the widest ranges of containers serving over 14,000 companies in the pharmaceutical, cosmetic, food and beverage and personal care industries. Even though it isn’t a highly followed business, Richards Packaging is still very shareholder friendly, with over a decade of return on invested capital of above 25 per cent. It boasts leading domestic market share in the container industry and a very healthy and sustainable dividend yield of 3.4 per cent, with a 60 per cent payout ratio thanks to a robust stream of operating cash flows. Underfollowed companies can be great investments as they can be inefficiently valued by the market.