May 28, 2018

Teal Linde's Top Picks: May 28, 2018

BNN Bloomberg

Teal Linde , BNN Bloomberg

Teal Linde, manager of the Linde Equity Fund
Focus: North American large and mid-caps

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MARKET OUTLOOK

Blockbuster earnings season but tepid market reaction

First-quarter earnings for the S&P 500 have been nothing less than a blockbuster as companies have reaped the benefits of U.S. corporate tax cuts and a strong increase in sales. With 93 per cent of companies having reported Q1 results, it appears that S&P 500 Q1 operating earnings will rise 26.3 per cent compared to the same period last year, marking the biggest year-over-year increase in quarterly earnings since Q4/10, when companies were in full recovery mode from the Great Recession. Of companies that have reported Q1 earnings, 77.3 per cent beat analyst estimates, which is far ahead of the 68.6 per cent average beat rate of the last five years. Corporate profit margins jumped to 11.1 per cent in Q1: by far the highest quarterly margin in recorded history, beating the 10.3 per cent recorded in Q4/17.

The stock market hasn't reacted as one might expect to this blockbuster earnings environment in 2018. So far, the S&P 500 is essentially flat on the year and the market has been treading water since it peaked on Jan. 26 (there's not been more than a two-week winning or losing streak since that peak).

Despite the blockbuster earnings, the combination of already elevated price-to-earnings ratios, rising interest rates, trade war fears and tech sector regulation scares have suppressed the market from jumping in tandem with significant earnings growth. Looking ahead, however, the momentum of strong corporate performance is likely to sustain longer than macro sentimental fears, which tend to be fleeting. Consequently, investors face a constructive outlook for eventual market upside as we move through the balance of the year.

TOP PICKS

FACEBOOK (FB.O)
Last purchased on April 20 at $166.64.

Facebook is the world’s leading social network company. It also owns the increasingly popular Instagram. With 2.2 billion users, nearly half of all Internet users are on Facebook, spending 20 to 40 minutes per day on average on the site. Facebook’s growth strategy is straightforward: Build the user base, increase engagement and then monetize. Following the furor over the Cambridge Analytica data scandal, Facebook reported strong first-quarter results. Revenues increased 49 per cent year-over-year to $12 billion while earnings per share (EPS) increased 63 per cent to $1.69 per share, beating analysts’ estimates by 25 per cent. Monthly active users were 2.2 billion, 13 per cent higher than the prior period. The day following the announcement, Facebook’s shares jumped 9 per cent, and have since fully recovered back to its pre-scandal price level. Facebook is expected to grow revenue and EPS 39 per cent and 25 per cent respectively in 2018. This is up from 36 per cent and 18 per cent growth just three month ago. Facebook trades at 24 times 2018 expected EPS of $7.67 (up from an estimate of $7.25 three months ago).

ALIBABA (BABA.N)
Last purchased on April 24 at $172.38.

Alibaba is a Chinese Internet company with business units ranging from its core e-commerce platforms to supporting businesses such as cloud computing (with over a million paying customers), payments and marketing services. The e-commerce businesses, controlling over 80 per cent of China’s spend online, combine to make Alibaba the largest online and mobile commerce company in the world by gross merchandise value. Alibaba operates under a marketplace model (inventory is sourced via third-party sellers) and partners with third-party logistics providers to ensure delivery to end-customers (it does not own warehousing facilities). The company operates in China through retail marketplaces comprising three brands: Taobao.com, Tmall, and Juhuasuan. Alibaba is expected to grow revenues and EPS approximately 59 per cent and 25 cent respectively, in the current fiscal year while trading at a forward P/E of 30.

INTACT FINANICAL (IFC.TO)
Last purchased on April 27 at $98.16.

Intact Financial is the largest property and casualty insurer in Canada with a mid-teens market share. Its product mix is roughly two-thirds personal lines (auto and home) and one-third commercial lines. The company has well-established track record of outperforming the industry's profitability. Intact’s return on equity (ROE) is over 500 basis points above the industry average over the last 10 years. They also have a great track record of growth through a series of acquisitions. Since its IPO in 2009, Intact has increased EPS at a 11 per cent compound annual growth rate, exceeding its long-term goal of 10 per cent. Intact is able to leverage its scale to achieve competitive advantages in pricing and segmentation (more data, more actuaries, and better technology), and claims (through internalizing all functions and supply chain savings), which drives margin improvement. Organic growth is supplemented by earnings-accretive insurance company and insurance broker acquisitions. Unlike the Canadian banks, Intact also has plenty of opportunities to continue consolidating its still-fragmented industry in Canada. With 70 per cent of Intact’s business in auto (50 per cent) and home (20 per cent) insurance, Intact also provides better downside risk protection if macro conditions worsen, given its defensive attributes operating in the property and casualty insurance industry. Its stock has recently pulled back, offering an attractive entry position.