Nov 7, 2017

Cameron Hurst's Top Picks: November 7, 2017

BNN Bloomberg

Cameron Hurst , BNN

Cameron Hurst, chief investment officer at Equium Capital Management
FOCUS: U.S. equities
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MARKET OUTLOOK

At Equium Capital, we feel the landscape for asset management is in the midst of a critical evolution, wherein exchange-traded funds (ETFs) are becoming significantly more influential for individual investors, advisors and institutional players alike. Our work suggests the underlying strategies that have worked over the last 10 years will continue to work for the next 10 years; however, technology and the availability of information have empowered the individual investor, enabling them to tap directly into markets and asset classes globally and resulting in great asset flows controlled directly by them.

They say necessity is the mother of all invention. Out of the need to reduce costs and streamline the complicated process of accessing global markets and asset classes, ETFs took a leading role. Nearly all the assets in ETFs today are in passive strategies reflecting everything from the TSX to emerging market debt, driving fierce competition and dramatic price compression, much to the benefit of individual investors.

So-called “smart beta” ETF strategies, which typically involve a quantitative overlay that underweights and overweights certain constituents of an index were an attempt to garner a higher fee for a superior product. Unfortunately, we have yet to see compelling research that supports the idea that they regularly outperform their higher fees, and we’re starting to see some fund families get rolled up into other companies. It seems fee compression will find its way to this segment too.

This leaves the smallest niche of the ETF industry: active ETFs, quietly yet successfully evolving into a more strategic force. Here, too, fees have been compressed. What used to carry a management fee of two to three per cent is now 1 to 1.5 per cent, but it seems to be levelling off there because of a genuine value-added benefit. And that’s the difference in the problem these ETFs look to solve: should investors be asking what assets in Canada to invest in or whether they should be investing in Canada at all?

After significant development, Equium Capital has launched a proprietary ETF (ETAC.TO) to offer our Global Tactical Allocation Fund through an exchange-traded vehicle to address the continuing challenges of where to invest, when, and in what proportion. Knowing when to invest at home from when France or India or the U.S. offers superior risk-adjusted opportunities – and in what asset class – remains very challenging work. While passive ETFs have enabled investors with the tools to invest anywhere, they don’t do anything for knowing when to invest and for how long and in what currency.

Now investors can place some of their core capital in a tactical global multi-asset strategy that seeks to address capital allocation in a conservative, mindful way, thinking of capital protection first and then aiming to deliver reasonable upside return of the full market cycle.

Right now, that strategy remains invested significantly outside Canada, although we’ve been raising the Canadian equity weight for the last month closer to neutral on the back of improvements in energy. Outside of Canada, we’re focused in France, Germany, India, and the U.S., specifically U.S. materials, energy, health care and financials. The fund is significantly tilted towards risk assets, with equities overweight and at the expense of bonds. Cash was reduced to the minimum one per cent during the summer pullback in preparation for a fall and year-end rally. On currencies, we maintain our call “BoC policy error” call from September and remain long the U.S. dollar and the euro over the loonie.

TOP PICKS

BECTON DICKINSON & CO. (BDX.N)

Sector: Health care
Assets: $51.1 billion

Performance

1 Year absolute: 29.8%
1 Year versus sector: 5.2%
1 Year versus S&P 500: 3.1%

Valuation

Top line growth

FY17: -2%
FY18: +13%
FY19: +2%

Bottom line growth

FY17: +7%
FY18: +14%
FY19: +9%

P/E multiple

FY17: 23.5x
FY18: 21.2x
FY19: 19.2x

Strong end market fundamentals for CAPEX exposed medical device companies and BDX should benefit from 2017 close of CR Bard acquisition. Medical device names generally escape the ongoing drug pricing debate – no headline risk here. Ongoing solid worldwide hospital capital spending environment is a positive for hospital CAPEX names like BDX. BDX is a diversified business with segments exposed to several major markets such as diabetes, infectious diseases and diagnostics. BDX is also diversified across the globe with over 40 per cent of its revenue generated outside the U.S. The company is exposed to positive demographic trends with aging populations needing greater amounts of drug delivery equipment. Bard acquisition is expected to close before year end 2017.

Clear strategic rationale for acquiring Bard’s Oncology and Urology businesses given BDX’s focus on medication management and infection prevention. BDX’s emerging market exposure is among the highest of its peers. Leveraging Bard’s portfolio across BDX’s infrastructure represents a multi-year growth opportunity with EMs typically growing at HSD (vs DM MSD). This transaction likely moves BDX to a higher growth profile from 4.5-5.0 per cent to more like five to six per cent top line. Management expects low-single-digit (per cent) accretion in FY18 and HSD in FY19. Total cost synergies of $300M are expected.

Use dividends to return capital to shareholders. The company offers a 1.5 per cent dividend yield, which is extremely safe due to a payout ratio of 30 per cent. Solid Q4 Earnings season (calendar Q3). Management issued better than expected FY18 EPS guidance - guidance likely conservative as it does not include the impact of Bard deal. Emerging market revenue growth was strong - with China driving growth. On 2018 P/E basis BDX trades in line with its historic average and below its peer group average (29.2x).

DOWDUPONT (DWDP.N)

Sector: Materials
Market Cap: US$165B

Performance

1 Year absolute: 33%
1 Year versus sector: 7%
1 Year versus S&P 500: 9%

Valuation

Top line growth

FY17: n/a
FY18: +6.5%
FY19: +5.0%

Bottom line growth

FY17: n/a
FY18: +20%
FY19: +19%

P/E multiple

FY17: 20.5x
FY18: 17.2x
FY19: 14.5x

Materials sector has broken out as base metals have performed well and chemicals names benefit from strong industrial growth. DWDP positively pre-announced their first quarter (Q317) as a merged company although underlying details were more mixed, guidance slightly below consensus and the corporate breakup was delayed by several months. Given the hurricanes and restructuring efforts however near-term estimates are not a good guide and we do not view the delay as material to the thesis. Underlying volume trends have been positive as key end markets continue to post solid growth (plastics, housing, auto, construction) and pricing should be supported by increasing commodity prices.

DOW/Dupont merger will result in significant cost synergies (US$3B target could be conservative) and more efficient corporate structure (will be broken into three parts: Ag, Materials, and Specialty that have their own cycles and drivers), which will help crystalize the SOTP argument. DOW is a key beneficiary of the U.S. shale gas boom, which provides it with a cost advantage relative to global peers (specialty plastics). DOW has pushed significantly more towards higher quality consumer facing verticals and away from cyclical industrial and commoditized businesses and driving up margins and cash flow, in turn resulting in peer and market leading shareholder performance over the last five years.

10x '18 EV/EBITDA is close to prior peak (DOW), however economic growth and commodity inflation will likely sustain earnings growth, while the strategic shift up the value chain, cost savings and breakup of the company into a more efficient structure should lift both estimates and multiple. All in, as long as the economy and inflation show progress and management continues to execute their strategic plan, we would expect the stock to move steadily higher over time.

E*TRADE FINANCIAL (ETFC.O)

Sector: Financials
Market Cap: $9.7B

Performance

1 Year: +55%
1 Year versus financials: +19%
1 Year versus S&P 500: +31%

Valuation

Top line growth

CY17: +21%
CY18: +9%

Bottom line growth

CY17: +33%
CY18: +13%

P/E multiple

CY17: 19.3x
CY18: 17.1x

Strong cyclical tailwinds and multiple drivers of organic growth with optionality from potential for takeout. New management committed to growing top line or realizing value other ways; to date this hasn’t been a problem with top line acceleration for six straight quarters and now in acquiring mode, buying RIA and Trust Co of America recently. Higher rates are a natural revenue tailwind. Management guided to low-270s bps NIM for 2017 versus 274 bps in the most recent quarter, so clear to see management conservatism. Previously noted a 25bps rate hike in June would increase this by 10bps, so pass through is significant. Announced a $1 billion share buyback to be completed before the end of 2018 boosting top line impact.

Share count expected to fall by 10 per cent in 2018. Mortgage loan book is now down to $3 billion, -25 per cent YoY, and fully amortizing. Tax reform beneficial because they’re a 38 per cent payer. Stock has had a great run as investors got wise to the story, so now valuation is running at highs of the historical range resulting in increased execution risk to the strategy (though we would argue it’s more than offset by the multiple growth drivers and takeout optionality).