Aug 31, 2016

Mohsin Bashir's Top Picks: August 31, 2016

BNN Bloomberg

Mohsin Bashir , BNN

Mohsin Bashir, Vice-President, Investments, Stone Asset Management

FOCUS: North American Large Caps

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MARKET OUTLOOK:

Slower global economic growth below 3 per cent seems to be the continuum. Central bank deferrals and easy monetary policy are contributing to the self-fulfilling prophecy of ‘lower-for-longer’ and the Brexit vote in the U.K. supports this notion, as markets digest both its near-term and long-term impacts. In North America, the U.S. election is occupying a great deal of media real-estate and attention in an election that is often reminiscent of reality-TV. While the economic landscape will not experience radical change no matter who wins the title of President, the political ripple-effects could impact global trade, GDP and industry regulation over the medium term. Extended low interest rates have resulted in perverse valuation premiums for bond-proxies such as REITs, telcos, and utilities. The deferral of US interest rate hikes has also seen a significant pick-up in gold/precious metals. Meanwhile, oil has experienced a recovery from its sub-30 levels, but has had difficulty staying above $50/barrel. Several market cross winds are resulting in a crowding of bond-proxy and ultra-cyclical equities while the belly of the normal distribution making up all equity investments continues to be overlooked in relative terms. The longer the world remains on interest-rate life-support, the longer these sector overvaluations of the tails will persist.

Overall, the corporate sector continues to hold its own, but earnings growth is subdued and the bar is set pretty low for forecasts. Balance sheets are healthy. The bear market appears to have gone back into hibernation. Stocks are not excessively rich, nor are they cheap at 18x estimated 2016 earnings. However, pushing that multiple forward to 2017 gives them still room to run further currently just under 17x. These were similar conditions last year. Near-term volatility in the stock market linked to uncertainty about the timing of Fed Reserve rate hikes prevails, commodity price sensitivity and relative currency sensitivities are of part this dynamic. As difficult as it is to find attractive valuations at the moment, our preference is for seeking out serial growers of dividends; but we recognize that aggressive share buybacks have also presented reasonable forms of returns on invested capital amid a benign growth environment.

Top Picks:

CVS Health (CVS.N) most recent purchase: $93.70/sh - Aug. 25, 2016

In the U.S., the Healthcare sector now accounts for 8 per cent of consumer spending and this is expected to increase another 2 per cent by the year 2020 – of what has been estimated to be over $15 trillion in consumer spending. Growth drivers for this industry include a combination of regulatory changes, mix shift and demographics. The pharmaceutical industry is limited to a handful of players at each vertical. Some companies by virtue of acquisition and organic growth have started to overlap and have a presence in several verticals and this theme of industry consolidation has led to continued market share attrition and margin expansion (retention) opportunities for the larger players. CVS has one of the best diversified business models in the industry combining both retail pharmacy and pharmaceutical benefit-management (PBM) businesses. This supports higher adjusted margins versus its retail peers and validates a higher valuation multiple. We view current pricing as attractive given prospects for the company to generate future earnings above $6.50/share which would indicate a forward P/E near 14x.

Emera (EMA.TO) most recent purchase: $48.43/sh - Aug. 4, 2016

Headquartered in Halifax, Nova Scotia, Emera is a diverse utility company with over 80 per cent of their adjusted earnings tied to stable growth rate-regulated operations. The recent acquisition of TECO Energy in Florida for $6.5B US dollars expands the company’s footprint and is anticipated to deliver 5 per cent accretion by 2019. Consequently, Emera’s board of directors approved a 10 per cent increase to its quarterly dividend to $0.5225/share with plans to continue growing dividends at an annualized rate of 8 per cent through 2020.

Power Financial (PWF.TO) most recent purchase: $29.44/sh - Aug. 23, 2016

Buying a high-quality business when it is out-of-favour has been a solid investment strategy for many value-investors with a long-term time horizon. Power Financial is a basket of many high-quality businesses that are out of favour by virtue of the low-interest-rate environment we have been in for several years and counting. Despite the immediate challenges to its insurance and wealth management businesses, the management team at Power Financial has been diligently deploying capital toward financial technology assets and investing in optimization and cost-reduction initiatives allowing the stock to return to a dividend-growth classification. PWF has been investing in disruptive financial service businesses like Wealthsimple, Borrowell Inc., League Inc. and Koho Financial Inc. targeting the younger demographic of DIY investors who have an affinity for products and services that can provide immediate gratification. These are high growth businesses packaged under a very large and stable umbrella valued at only 9.4x forward P/E and trading at a 17 per cent discount to net-asset-value. Did I mention that you also get a 5.2 per cent dividend while you wait for the yield-curve to steepen?