Nov 8, 2018

Norman Levine's Top Picks: Nov. 8, 2018

BNN Bloomberg

Norman Levine , BNN Bloomberg

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

MARKET OUTLOOK

The mid-term elections in the U.S. have come and gone and the best possible result for the markets, gridlock, has occurred. Markets like gridlock as it helps ensure that governments can’t pass any nefarious legislation. Now, markets can look forward to some seasonal lift (especially in the U.S.) as November and December are generally positive months for stocks. That said, U.S. markets aren’t cheap by any means, whereas European, Asian and even Canadian markets are looking more attractive. Investors should be looking to move some money over the next few months from the U.S. to other areas. Another area that’s looking attractive is preferred shares, as panicked retail selling in recent weeks has brought yields to very nice levels, especially in rate-reset preferreds resetting in the next year or so.

TOP PICKS

WELLS FARGO (WFC.N)
Bought on Oct. 12 at $52.16.

Wells Fargo is the world’s second-largest bank by market capitalization and the fourth-largest bank in the U.S. by total assets. It provides banking, mortgage, investing, credit card and personal, small business and commercial financial services to its clients.

The opportunity to purchase a strong U.S. banking franchise exists due to a large number of missteps made by Wells Fargo in recent years, all of which should be corrected. In other words, these are temporary issues as opposed to permanent ones. They include establishing fake accounts, illegally repossessing cars, selling dangerous investments, among others. These issues led to congressional and SEC probes and in February 2018, the U.S. Federal Reserve limited Wells Fargo growth until it solved them.

Another headwind is the U.S. yield curve, but over time, it should go back to normal. From a valuation point of view, Wells Fargo is very reasonably priced and given its franchise quality, it could even be considered cheaply priced. It trades at approximately 12.2 times 2018 earnings per share (EPS), 10.5 times 2019 EPS and 9.1 times 2020 EPS. It has a dividend yield of 3.2 per cent. Once these temporary issues are resolved over the next two to three years, the bank should re-price to a higher price-to-earnings multiple as its earnings grow. An added benefit is that Berkshire Hathaway is a significant shareholder.

NXP SEMICONDUCTORS (NXPI.O)
Bought on Oct. 16 at $80.59.

NXP makes semiconductors (chips) for a variety of uses, but it specializes in two main areas: driverless cars and connected factories. Both of these are growth areas today and in the future. The company should be able to grow its revenue in the 5 to 7 per cent range.

NXP’s valuation today is 12.5 times 2018 EPS. This reasonable price-to-earnings multiple given its growth rate is due to the fact that Qualcomm had to abandon its acquisition of the company earlier this year due to the U.S.-China trade dispute. In a takeover deal, the main shareholders change from long-term shareholders to arbitrageurs who are looking to make a profit from the takeover deal. Once a deal is abandoned, this dynamic goes into reverse: short-term arbitrage traders look to exit and long-term shareholders look to enter. However, there is a mismatch in the time horizon, causing in this case a sizable drop in the stock price. Qualcomm was willing to pay $127.50 for NXP, whereas NXP today trades at $85. Given today’s trading price, a corporate acquirer has determined that value of the company is $127.50, which would result in upside of almost 50 per cent if another acquirer were to show up.

In terms of valuation, at $85, NXP trades at 12.5 times 2018 EPS, but the story gets more exciting with the passage of time: at $85, it trades at 10.4 times 2019 EPS and at 8.9 times 2020 EPS. These are very cheap multiples given NXP’s growth rate. Once the arbitrage selling pressure subsides, the shares should reprice upwards.

LANXESS (LNXSF.PK)
Bought on Jan. 22, 2018 at €74.

Lanxess is a high-quality, German-based specialty chemicals maker that was spun out of Bayer in 2004. It trades at 6.8 times enterprise value (EV) to earnings before interest, tax, depreciation and amortization (EBITDA). The new CEO (who was the CFO in past years), is looking to make the company a specialty chemicals powerhouse by 2020. They have made many moves under his leadership, including selling 50 per cent of a large commodity business to Saudi Aramco and using the proceeds to pay down debt. The company is a huge cash generator. In 2017, they purchased Chemtura in the U.S., making Lanxess one of the largest players in the flame retardants and lubricant additives business in the world. Lanxess should be able to grow EBITDA by around 10 per cent yearly over the next number of years, as they have in the last few years. In addition to acquisitions, the CEO is undertaking a second cost-cutting program, which should be completed by the end of 2019. The stock currently trades at 56 euros and is most likely worth around 100 euros (8 times EV/EBITDA plus cash build about 18 months out). The dividend yield is 1.4 per cent. Lanxess also has Berkshire Hathaway as a shareholder. It currently holds 5 per cent of the common shares.