Full episode: Market Call for Friday, July 7, 2017
Cameron Hurst, chief investment officer at Equium Capital Management
Focus: U.S. equities
- Job creation has been running at an average of 207K each month for the last five years, with unemployment at the lowest level since the peak of the tech boom in 2000 and jobless claims at the lowest level in 30 years.
- Corporate debt spreads are decisively benign at present.
- BBB spreads over the 10-year Treasury are at the lowest point since 2014 and trending down.
- This means market participants feel there’s less risk of default in the riskiest tranche of investment grade debt than at any point in the last three years.
- Corporate earnings are stronger than at any point post-financial crisis.
- 1Q’17 results for the S&P 500 companies saw revenue and EPS growth over seven per cent and 15 per cent, respectively.
- Expectations are for double-digit EPS growth again this quarter and then potentially slowing to a more sustainable high-single-digit level.
- European earnings growth is even better, perhaps reflecting the slower progress there vis-à-vis the U.S. 1Q’17 revenue and EPS came in over 10 per cent and 23 per cent, respectively. Even excluding easy comps from energy and materials, EPS growth still hit mid-teens.
- Valuations can be deceiving, but we’re not worried at present.
- There’s a very strong relationship between 10-year S&P 500 returns and the starting P/E level, with an 85 per cent correlation.
- But there’s virtually no relationship at all between P/E multiples and one-year returns.
- Yes, multiples have expanded a bit YTD — but about two-thirds of the market return this year can be attributed to earnings growth, not multiple expansion.
- The average mid-cycle market P/E since 1982 is 18.6x compared to the current full-year 2017 estimate of 18.5x.
- We would thus argue the fundamental backdrop for most sectors is robust, even if there are notable potholes to avoid, like energy.
- Staying engaged when market noise ratchets up, as it has this year, can be as difficult as disengaging when market signals are telling you it’s time to put defence on the field.
- The important part is knowing when to recalibrate and having an established process and strategy that’s tactical and unemotional, for example:
- The technicals for information technology rolled over this quarter, so we exited our overweight in June to lock in profits and protect capital.
- Concurrently, health care assumed a stronger leadership position in the U.S. market, so we tactically rolled the capital and profits from our U.S. tech position into a more robust exposure in health care.
- Sector: Health care
- Assets: $1.61 billion
- Expense ratio: 0.44%
- 1 year absolute: +21.2%
- 1 year versus health care: +10.5%
- 1 year versus S&P 500: +3.5%
- Valuation (top 10 holdings):
- Top-line growth: FY17 +7%, FY18 +6%
- EPS growth: FY17 +11%, FY18 +11%
- P/E multiple: FY17 21.8x, FY18 20.1x
- Strong end-market fundamentals and early-stage pipelines should continue to drive long-term growth.
- Medical devices generally escape the drug pricing debate — no headline risk here.
- Number of positive secular trends: aging population, obesity epidemic, emerging market demand.
- Both proposed U.S. health care bills would repeal Medical Devices Excise tax.
- Currently in the early stages of new product pipeline.
- Positive end-market fundamentals
- Cardio: Expect global TAVR market to grow at 20 per cent to 2020.
- Ortho: Stable to improving volumes.
- See opportunities for M&A where larger names (JNJ, MDT) look to fill “holes” in their portfolios.
- BCRA bill looks to repeal 2.3 per cent Medical Devices Excise tax.
- Tax was introduced as a funding mechanism under ACA.
- Was suspended in 2015 until December 2017.
E*TRADE FINANCIAL (ETFC.O)
- Sector: Financial services
- Market cap: $10.6 billion
- 1 year absolute: +67%
- 1 year versus financials: +28%
- 1 year versus S&P 500: +49%
- Top-line growth: CY16 +36%, CY17 +16%, CY18 +8%
- Bottom-line growth: CY16 +48%, CY17 +14%, CY18 +16%
- P/E multiple: CY17 19.5x, CY18 16.7x
- Multiple drivers of organic growth with potential for takeout.
- New management in September committed to growing top line or realizing value other ways.
- Higher rates are a natural revenue tailwind.
- Management guided 250bps NIM for 2017 and noted a 25bps rate hike in June would increase this by 10bps, so pass thru is significant.
- Asset growth coming in faster than previously expected.
- Mortgage loan book is now fully amortizing and under $4 billion from over $20 billion in 2009.
- Tax reform beneficial because they’re a 38 per cent payer.
- If management hits a revenue wall (pricing competition) and wants to sell, AMTD would be more interested now that the mortgage book is running off aggressively.
- All adds up to a nice one- to two-year story with a chance to buy on the pullback from pricing risk.
- Sector: Industrials
- Market cap: $58.4 billion
- 1 year absolute: +44.3%
- 1 year versus industrials: +21.5%
- 1 year versus S&P 500: +26.5%
- Top-line growth: FY17 +11%, FY18 +6%, FY19 +4%
- EPS growth: FY17 +15%, FY18 +12%, FY19 +15%
- P/E multiple: FY18 15.9x, FY19 14.4x
- Strong, secular e-commerce trends and company-specific margin expansion programs.
- Strong technicals.
- Positive secular trends: growth in e-commerce with an increasing breadth and depth of products sold online continuing to drive parcel carrier volume trends above growth GDP.
- Improving ground network efficiency, which should drive margins to mid-teens target — consolidating ground locations and combining its commercial and residential drivers to single independent service provider.
- TNT acquisition will strengthen European network. Expect deal to be accretive in 2018 by improving margins at TNT (simplification of pickup and boost delivery density).
- FedEx Freight (10 per cent of revenue) is the leading “less-than-truckload” provider in U.S. and so should benefit most from industrial recovery.
- Potential lower U.S. corporate tax rate a big positive.
- Trades at a near 21 per cent discount to U.S. peers on a P/E basis and at near-record discount to UPS.
PAST PICKS: MAY 20, 2016
UNITEDHEALTH GROUP (UNH.N)
- Sector: Health care
- Market cap: $174.2 billion
- 1 year absolute: +35.2%
- 1 year versus health care: +22.5%
- 1 year versus managed care: +0%
- 1 year versus S&P 500: +16.3%
- Top-line growth: FY17 +8%, FY18 +8%
- EPS growth: FY17 +22%, FY18 +10%
- P/E multiple: FY17 19.2x, FY18 17.4x
- We like managed care fundamentals generally given the changing health care model. Look for buying opportunities on further DOJ case noise.
- Large diversified enterprise both in terms of breadth of services and geographic reach and is a market leader in virtually every business segment that it operates.
- Supported by secular trends in Medicare and Medicaid, i.e. aging population and lifestyle diseases; the company has significant demographic tailwinds for years to come.
- Changes in health-care delivery and payment models (fee for services to value-based) favours entities positioned to reduce per capita health-care spending — puts managed care in good position.
- Minimal impact and exposure of ACA repeal/replace on large diversified managed care companies. Could see positive impact of the Senate Bill — state Medicaid per capita spending caps will likely accelerate shift from FFS to managed care.
- Returns about 50 per cent of annual cash flow to shareholders as dividends and share buybacks.
- A risk to the company: DOJ is looking into case alleging UNH made efforts to identify sicker members in its Medicare Advantage plans in order to code for their health status and receive commensurate higher-risk payments from the government. Little evidence to substantiate fraud claims and DOJ intervention in past has not guaranteed material finding.
- Top and bottom lines beat and raised guidance.
- Then: $130.94
- Now: $188.14
- Return: +43.68%
- TR: +46.72%
- Sector: Energy
- Market cap: $91 billion
- 1 year absolute: -12%
- 1 year versus energy: -9%
- 1 year versus S&P 500: -25%
- Top-line growth: CY16 -22%, CY17 +8%, CY18 +17%
- EPS growth: CY16 -82%, CY17 +152%, CY18 +87%
- P/E multiple: CY17 45.75x, CY18 24.5x
- We’ve been negative on energy since the beginning of the year as the technical picture broke down.
- SLB remains the premiere global oil services company with a strong balance sheet and cash flow generation through the cycle.
- Near term however, SLB’s large international exposure is more than offsetting a recovery in U.S. shale leading to continued downward earnings revisions. With continued oil price weakness, 2018 could be another year of limited global E&P CAPEX growth.
- Cameron deal performing well with synergies ahead of target. Effective tuck-in M&As continue to build the company’s technology and market share advantage.
- Realistically, the price of oil needs to recover to $60 or higher for the stock to work and we don’t expect supply/demand imbalance until early 2018 though forecast risk is very high.
- Then: $74.96
- Now: $64.69
- Return: -13.70%
- TR: -10.89%
- Sector: Materials
- Market cap: $16 billion
- 1 year absolute: +7%
- 1 year versus materials: +9%
- 1 year versus TSX: -1%
- Top-line growth: CY16 +38%, CY17 +9%, CY18 +6%
- EPS growth: CY16 +104%, CY17 -2%, CY18 +13%
- P/E multiple: CY17 71.7x, CY18 63.6x
- Currently 91 per cent of revenues from precious metals (71 per cent gold) with long-term goal of reducing to 80 per cent.
- Recent $110-million purchase of Permian oil and gas assets anchored by Pioneer (O&G now six per cent of revenue). $1.5 billion of available capital for future deals.
- Low capital intensity, no debt, well diversified (no asset over 15 per cent of EBITDA)
- Stock performance has been highly correlated with gold’s up/down/up move over the last 12 months though longer-term compounds are much better than gold and gold miners. Performance gap has opened up in last couple of months though versus gold (+10 per cent relative Q217).
- Going forward, we continue to believe in the global reflation theme, which should lead to higher interest rates and a higher USD, which would reverse gold’s recent outperformance. Therefore neutral on the outlook for the shares.
- Then: $65.52
- Now: $69.79
- Return: +6.51%
- TR: +8.33%
TOTAL RETURN AVERAGE: +14.72%