Aug 27, 2018

Zachary Curry's Top Picks: Aug. 27, 2018

BNN Bloomberg

Zachary Curry , BNN Bloomberg

Zachary Curry, president and portfolio manager at Davis Rea
Focus: North American large caps

MARKET OUTLOOK

The global, U.S. and Canadian economies remain on a solid footing as we head toward 2019. Rising U.S. short-term interest rates, trade frictions and weaknesses in some emerging market economies suggest a slower pace of expansion ahead, but recession is unlikely in the next twelve months.

Higher U.S. rates are the main risk to growth, but that’s more of an issue for late 2019. This growth backdrop is a plus for corporate earnings and commodity prices. Underlying inflation remains low both globally and in North America though low unemployment rates have tilted the risks upward. U.S. and Canadian short-term interest rates have been rising in response and will likely edge higher in the months ahead. NAFTA risks will keep the Bank of Canada on a more cautious path than the Federal Reserve, and weigh on the Canadian dollar in spite of expected gains in commodity prices.

Equity prices have been caught in a tug-of-war between rising U.S. short-term interest rates and escalating trade tensions, which are negative, and growing earnings, which are a plus. Yet valuations have declined considerably this year as markets have digested the risks associated with higher rates and trade tensions, implying a more favourable risk/reward profile in equity markets over the next six to nine months.

Valuations have improved across all sectors in 2018 and several areas of the market are attractive. The two areas that really stand out are Canadian energy and U.S. banks. Energy companies will continue to benefit from higher oil prices, especially if there’s a major supply disruption in the Middle East. The backdrop is positive for U.S. banks as the global economy and U.S. consumer re-leverage themselves and U.S. regulations are scaled back.

TOP PICKS

JPMORGAN (JPM.N)
Most recent purchase: June 26, 2018 at US$104.94.

JPMorgan is the largest bank holding company in the U.S., and the third-largest bank in the world (by assets). It’s one of the best all-around banking franchises as a leader in consumer and commercial lending, asset and wealth management, and in investment banking. Despite the recent volatility in fixed income trading that have negatively affected investment banks over the last year, JPMorgan’s investment bank remains well positioned in both equity and debt underwriting, and advisory. As one of the most diversified banks, JPMorgan is able to benefit from an improving U.S. economy. Rising interest rates should help net interest margins, while the commercial bank should benefit from greater economic activity from corporations. U.S. consumers have improved balance sheets and are looking to re-lever through consumer credit. JPMorgan has been invested heavily into technology, spending US$9.5 billion to increase efficiency in legacy operations, and into new investments and innovations, which should position them well for the future. Due to tax reform, its effective tax rate has dropped by 10 per cent. We anticipate increased shareholder returns coming through the form of buybacks or increased dividends (JPMorgan currently yields around 2 per cent).

BROOKFIELD INFRASTRUCTURE PARTNERS (BIP_u.TO)
Most recent purchase: Feb. 6, 2018 at $51.83.

Brookfield Instructure Partners owns and operates infrastructure assets such as utilities, toll roads, pipelines, network towers, and ports globally. Brookfield Infrastructure has a great track record when it comes to managing their portfolio and deploying/recycling capital. They routinely acquire interests in infrastructure companies or projects, invest capital to provide operational improvements, and then sell its interest afterwards. Their global reach enables them to find value worldwide and take advantage of improving global growth in both developed markets (Canada, U.S. and Europe) as well as emerging markets (Brazil, China and India). They recently sold their interest in their Chilean electricity transmission asset and have committed to acquiring the second-largest natural gas distribution system in Colombia. They have a large backlog of projects, with close to $1 billion being put to work in new projects over the next 24 months. Among these are the acquisition of AT&T’s U.S. data centre business, supplying colocation services to a wide range of customers, the acquisition of Enbridge’s Western Canada natural gas gathering and processing business, and the acquisition of Enercare, a provider of water heaters and water metering solutions. With infrastructure assets providing steady cash flow even in the face of rising interest rates and inflation (75 per cent of their revenue is indexed to inflation), Brookfield Infrastructure is able to grow organically and support the 4.6 per cent yield on the stock.

KEYERA (KEY.TO)
Most recent purchase: May 7, 2018 at $35.99.

Keyera is involved in natural gas gathering and processing as well as natural gas liquids processing, transportation, storage and marketing. It has an excellent management team that has consistently delivered strong results over the years. The shares currently yield almost 5 per cent, with the company having just increased its dividend by 7 per cent. Keyera’s payout ratio is fairly low at 56 per cent as of Q2/18. The company recently announced an agreement with a large producer to build a gas processing plant, the first phase to be in service in 2019, as well as increasing its ownership position at another facility. Both of these announcements expand Keyera’s presence in the U.S., particularly in Oklahoma. The balance sheet remains strong, with leverage ratios much lower than their peers.