Aug 14, 2018

Norman Levine's Top Picks: Aug. 14, 2018

BNN Bloomberg

Norman Levine , BNN Bloomberg

Norman Levine, managing director at Portfolio Management Corp.
Focus: North American large caps

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MARKET OUTLOOK

We’ve been in a bull market and economic recovery for over nine years. Needless to say, we’re closer to the end of both than to the beginning. That said, history shows a few things. First, economic expansions and bull markets generally go longer and higher than most people expect and the gains made late in the cycle can be significant, but they come with increased risk. Second, lots of things cause expansions and markets to end, including interest rates and external shocks. Overvaluation of stocks is rarely the reason. Most times, though, it’s something that comes out of the blue. Third, nobody knows when and why until it actually happens, so take with a big grain of salt the opinions of those who claim to know. Lastly, it’s prudent late in the cycle to give up some of the market gains in order to protect your capital. Over the next few months, we will be gradually increasing our cash as this bull gets even longer in the tooth.

TOP PICKS

BRIGHTHOUSE FINANCIAL (BHF.O)
Purchased Aug. 9, 2017 at $55.66 and currently buying for new clients.

Brighthouse was spun out from MetLife (MET.N) last August. It was the personal insurance side of the company. The original thesis was near-term stock pressure valuing it below book value because 1) lifecos were out of favour, 2) new spin had a lack of track record and hence a lack of investor interest and 3) there was no immediate dividend. We felt that this ultimately over time would correct itself and still do, but patience is required.

The company is in an industry that investors are uninterested in, with the entire group down double digits year to date. Persistently, low interest rates have hurt the industry’s business fundamentals as have issues in long-term care (Brighthouse is not in this segment) and VA guarantees (Brighthouse is in this one). Higher interest rates, resumption of historical levels of mortality, better products and conviction on adequate reserving for past mistakes would make investors return to the sector. The company, when it was spun out, stated they would not pay a dividend or return capital to shareholders until 2020 as it incurred expenses related to setting up its own corporate infrastructure. Given a lack of long-term track record at the time of the spin, we valued it at a slight discount to its closest peer, Lincoln National (LNC.N), which at that time traded at 1-time book value. Brighthouse’s book value estimate from last year for end of 2018 remains unchanged at about $103 per share. So it’s traded from 0.7 times book value to 0.4 times. The company has a solid capital position, but no capital return expected until 2020 (although it just announced a small buyback given it has excess capital available). Its industry group is out of favour trading well below its five-year average price-to-earnings. Risk is lower interest rates and lower equity markets (although the company has hedges in place) and at 0.4 times book value, that reserves for losses in a run-off business (VA guarantee) are not enough. Uncertainty is opportunity. During the 2008 crisis (not a relevant comparison, but shows how bad it got) Lincoln National traded at 0.2 times book before making its way back up to 1.0 times last year. Analysts are guiding investors to companies already returning capital versus a 2020 story.

SANOFI (SNY.N)
Purchased on July 7, 2016 at $41 and currently buying for new clients.

Sanofi (formerly Sanofi-Aventis) is a French-based multinational healthcare company focused on pharmaceuticals and human vaccines. Like most other drug stocks have experienced, Sanofi recently faced a patent cliff as many of its major drugs came off patent and, also like most other drug companies, its immediate product pipeline is pretty bare. Historically, this is the best time to buy drug stocks to make a lot of money: when nobody wants them. Sanofi has a great balance sheet and is using that money to buy companies with promising new products. It has a number of promising new drugs in early stages of its pipeline and has announced the sale of its European generics business. It has lost out on some major acquisitions due to its price discipline, but has purchased in recent years Ablynx, Protein Sciences, and Bioverativ. In the meantime, the company is keeping costs in line and the dividend is safe and provides a yield of about 4.5 per cent. It’s for patient investors, not people looking for quick money.

STANTEC (STN.TO)
Purchased on Sep. 14, 2016 at $30.22.

Stantec acquired a highly sought-after company (MWH) in 2016 that had good secular growth and high market share in water infrastructure. While Stantec is mainly an engineering and design firm, the acquisition came with a small portion of construction (about 7 per cent of revenues) that investors weren’t used to seeing in the results. Construction is inherently riskier than engineering and design and Stantec has been experiencing issues with a few legacy construction projects that had come along with its acquisition of MWH. Stantec has stated that they intend to sell either that part of the business either as a whole or sell the U.S. and U.K businesses separately. We hope to have news on this front by year-end. Stantec has strong exposure to the infrastructure plans of both Canada and the U.S. and has a healthy balance sheet for acquisitions. Should it decide to carve off the construction business, the stock would be quickly rerated higher. Stantec yields 1.6 per cent.