Jul 22, 2016

John Zechner's Top Picks: July 22, 2016

BNN Bloomberg

John Zechner , BNN

John Zechner, Chairman and Founder, J. Zechner Associates

Focus: North American Large Caps

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MARKET OUTLOOK:

Global economic growth remains weak, profit margins have peaked for this cycle and input costs, most noticeably wages, are starting to rise again. Stock valuations remain at the high end of all historical measures, supported almost completely by the zero/negative interest rate policies of global central banks. Those policies however are losing their impact and the marginal benefit of further easing is minimal, while the risks associated with this ongoing support continue to rise. Loan default risk in the Chinese banking system and global currency wars remain the biggest potential risks in our view.

The bottom line for us in financial markets right now is that the stock market rally has run its course and that stocks face more headwinds in the months ahead from weak earnings, slower global economic growth, high stock valuations and less impetus from aggressive central bank policies. We have moved back to an underweight position in stocks after selling almost all of our holdings in the gold and base metals sectors. We remain overweight U.S. stocks given that we expect further weakness in the Canadian dollar and have a higher comfort level with the valuation of U.S. banking, technology and transportation stocks. We also still have an overweight position in Canadian preferred shares given their yields of close to 6 per cent and the increasing institutional interest in this sector as a source of income.

Top Picks:

Alphabet Class 'C' (GOOG.O), Last purchase US$700

Best combination of value and growth in large technology universe. Alphabet remains well positioned to benefit from proliferation of connected devices and data management, which also allows the company greater access to consumer behavior info and apply that to sales patterns. It controls the largest search engine and owns the most prolific mobile software operating system (Android), and monetizing the value of its existing platform and supplementing with timely acquisitions (i.e. You Tube) from huge free cash flow. Earnings multiple in line with the overall market but growth potential much higher.

Martinrea International (MRE.TO), Last purchase at $7.70

Stock trading at lowest valuation of group but expecting >10 per cent earnings growth per year over the next three years as recent spending to roll out new programs starts to yield results. Profit margins will expand as these new growth platforms are more fully utilized and margins continue to rise. The company also has the best exposure in the industry to the increasing use of aluminum in autos, which is a substantial ongoing trend to lower overall production costs and operating efficiencies. Sector valuations are exceptionally low (already pricing in the next recession) as investors worry about ‘peak auto’ sales, but average age of autos in North America remain high suggesting less of a downturn.

Torstar Corp (TSb.TO), Last purchase $1.50

The stock has become excessively under-valued relative to its asset value due to mismanagement and a loss of investor confidence. Market cap is only $120 but has net cash position of over $50 million so enterprise value is only about $70 million, less than 40 percent of the $200 million the company paid to buy digital media company Vertical Scope last summer! Torstar also owns Toronto Star and Metroland newspapers which generate positive cash flow. StarTouch app spending is winding down and this should be cash neutral by end of year. The company continues to move to more digital platforms and away from ad dependence. The sale of Harlequin for $450 million was 40 per cent higher than most analyst estimates and is example of how investors are under-estimating the break-up value of the total company. Negative view on management/strategy/uses of cash/newspaper industry have created a significantly under-valued stock, even assuming dividend is cut further.