Dec 28, 2016

Norman Levine's Top Picks: December 28, 2016

BNN Bloomberg

Norman Levine , BNN

Norman Levine, managing director at Portfolio Management Corporation

Focus: North American large caps
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MARKET OUTLOOK
North American stock markets have been on a tear since the U.S. election. One thing to keep in mind, though, is that not all stocks and industry groups are participating. Many groups have declined (listed below) while other groups have soared. Stocks, in general, are advancing for good reason. We see the U.S. economy continuing to strengthen. This is positive for corporate earnings and calls for higher interest rates. While this will be positive for stocks in the long term, we see valuations stretched for many stocks and sectors and therefore, we will not be surprised by a correction, especially early in the New Year. Remember, we are almost eight years into the current bull market, so it is getting a bit long in the tooth. A correction to bring valuations back into line will be welcome and will give us a reason to spend some of our cash. Second, a stronger U.S. economy means higher yields on bonds and the Fed continuing to raise rates. This will be negative for the bond market until it finds its new equilibrium and negative for stocks and industries that have benefitted from the search for yield, ie. REITS, pipelines, utilities, telecom and multinational consumer staples. This will be positive, though, for financials (especially lifecos and U.S. regional banks), industrials, transportation companies and infrastructure companies. Also, it will continue to give a boost to some rate-reset preferred shares.

TOP PICKS

ARC RESOURCES (ARX.TO) – Owned by clients, self and family. Bought November 2014 at $28.55.
ARC is an oil and gas exploration and production company in Western Canada. While it operates in all four Western provinces, the majority of its assets are in the Montney play in Northeastern British Columbia. The recent sale of its Saskatchewan oil assets boosts its natural gas production percentage to 72 per cent versus 28 per cent oil. It is a low-cost and high-quality producer with one of the best managements in the business — exactly what you want in this type of environment. We are positive on the outlook for natural gas (much more so than oil), so view the company very favourably here. ARC currently yields 2.6 per cent.

TEVA PHARMACEUTICALS (TEVA.N) – Owned by clients, self and family. Bought December 19 at $36.74.
Teva is the largest generic drug manufacturer in the world and among the top 15 pharmaceutical companies worldwide. We are attracted to the healthcare area as we are value investors attracted to out-of-favour companies and industries, and this group is certainly out of favour. Teva is down over 40 per cent from the start of the year for a number of reasons including the genericization of Copaxone (which accounts for about 25 per cent of its revenue), the acquisition of Actavis from Allergan having not gone as smoothly as expected, worries about Trump and drug prices, and a high debt-to-EBITDA ratio following the acquisition. The stock is trading at 7X expected 2017 EPS, which is below its five-year average low P/E of 8X. Its average high P/E over that same time period is 10.5X. Its specialty drug and biosimilar drugs are quite interesting, but the stock is currently overwhelmed by the current negative news flow. Everyone hates it. That is when we have made money on this stock and other drug stocks in the past. Current yield is an attractive 3.7 per cent.

PFIZER (PFE.N) – Owned by clients, self and family. We have owned Pfizer for many years and continue to buy it for new clients.
Pfizer is one of the largest pharmaceutical companies in the world. It has historically grown through acquisitions, the most notable this century, including Warner-Lambert, Pharmacia, Wyeth and Hospira. Pharmaceutical stocks are out of favour and sell at a discount to the market in general, and Pfizer sells at a discount to the group due to its large size (making meaningful growth harder to achieve) and the substantial cash it holds outside of the U.S. Once again, this is an out-of-favour stock in an out-of-favour group — our kind of stock. While Trump’s talk of lower drug prices is negative for the entire group, his talk of reducing the tax rate for companies like Pfizer wanting to repatriate their cash to the U.S. far overshadows the pricing negative. We expect Pfizer will use that cash smartly to continue to grow through acquisition. It currently yields four per cent.