Originally published March 14, 2014
Last year’s record stock market rallies had investors flocking to equities. At the end of 2013, the TSX was up 9%, the S&P 500 had gained 29% and the Dow Jones rose a record 26.5%.
But the party may not last, so we asked four portfolio managers to identify stocks with strong fundamentals. Here are their picks.
01 Dennis Mitchell
executive VP & CIO,
Reckitt Benckiser Group PLC
This U.K.-based company focuses on health, hygiene and home care. Its 19 power brands, which include Scholl’s, Lysol, Clearasil, and Air Wick, drive more than 70% of revenues and are sold in nearly every country, including Canada, the U.S., India and China. More than 100 other products drive the remaining 30%.
Reckitt should deliver about 11% total returns. That could be higher if the European Central Bank and Bank of England continue monetary easing, which will make financing cheaper.
A sale of its non-core pharma business would permit focus on the core health and hygiene divisions, or return capital to shareholders.
Norma Group SE
Germany’s Norma makes hose clamps, quick connectors and fluid systems designed to take up less space and weight in a car’s engine compartment. Such systems cut emissions. Norma is set to grow faster than its end markets, which are mostly passenger and commercial vehicles. Customers include Volkswagen, Audi and BMW.
Barriers to entry are high, thanks to the firm’s patents and longstanding distribution agreements. This lets Norma maintain strong pricing power, margins and return on capital.
EU auto demand has rebounded in countries hit hardest by the debt crisis. In Jan. 2014, new car registrations were up 5.5% from Jan. 2013, according to the Association of European Automobile Manufacturers. And continued growth in China should help Norma deliver double-digit earnings and dividend growth, collectively around 12%.
At the end of Dec. 2013, Norma’s portfolio weight was 3.12%. We would increase that if global auto demand recovered slower than expected. But, we tend not to invest more than 5% in a company.
02 David Kunselman
senior portfolio manager,
Samsung, one of our top-ten holdings, manufactures semiconductors, handsets, TVs and home appliances, and sells them across North America, Europe and Asia.
It aspires to be the world’s top tablet maker, and research firm IDC finds it sold 41 million Galaxy tablets in 2013, second only to the Apple iPad (74 million).
Samsung has US$50 billion cash, compared to its USD$180 billion market cap. We can buy Samsung at less than seven times earnings (a discount, because historical multiples have been between seven and 11) because revenue growth fell to single digits in the latter part of 2013, from double digits the year before.
In addition, the South Korean won appears set to strengthen this year. In February, the Bank of Korea kept its policy rate at 2.50% for the ninth straight month, and inflation was 1.1% in Jan. The unemployment rate dipped to 2.97% in Dec.
We expect Samsung to rise more than 25%, with investors paying a higher price-to-earnings ratio of eight or nine times. Earnings are expected to increase at a single-digit rate, but today’s multiple is heavily discounting this. We would sell if margins decrease or earnings turn negative year over year.
The world’s largest luggage company, it went public in 2011 at $14 and now trades at about $20 on the Hang Seng. Its multiple is 17 times earnings, a 20% discount to its peers. While the luggage market is fragmented, Samsonite is twice the size of its next largest public competitor, Tumi Holdings Inc.
Samsonite’s market cap is $3.75 billion with no debt. Asia, where luggage purchases have climbed 15%, represents almost 40% of sales. And we’re expecting higher growth, roughly 20%, for China and India. Samsonite reported 18.6% sales growth in Q3 2013.
We’d sell if global conditions turn negative for air or railway passenger growth.
03 William Booth
Epoch Investment Partners
This global brewer has 17 billion-dollar brands in more than 80 countries, including U.S., Brazil, Mexico and Canada.
The company is attractively valued relative to its free cash flow, which we expect to grow at a low double-digit rate thanks to deleveraging, working capital management and moderating capex.
In 2013, the company’s euro-valued stock price was up 17.5% (21.2% including dividends). That should be supported by cost and revenue synergies with the acquisition of Grupo Modelo and its Corona brand, completed last year.
The company’s M&A transactions have been value-creating for shareholders. So if the company finds additional opportunities, we would be supportive even if it meant further delaying cash distributions to shareholders.
ABI plans to pay down acquisition-related debt in 2014, which has a benefit similar to a dividend: shareholders will have larger claims on cash flow. As of Dec. 30, 2013, the company had US$39 billion in debt and US$10 billion in cash.
The stock was a 1.9% position in the fund at the end of the year, and we’d buy more if the company were more aggressive about returning cash to shareholders through dividends or buybacks.
The largest global provider of consumer credit services, Experian maintains databases that it sells to the financial, retail, automotive and telecom industries. Growth in credit, especially in the emerging markets, and the threat of identity theft are underpinning Experian’s growth in free cash flow.
Its business model is resilient thanks to contracts and subscriptions, which helped it to grow revenues and margins each quarter during the downturn. The company has a track record of using its cash wisely, mostly for acquisitions, dividends and share buybacks. In Nov. 2013, it acquired Passport Health Communications, a U.S.-based secure payment company, for US$850 million. Shareholders saw that acquisition as expensive, but we saw a fit.
We’d add to the holding if we saw unjustified price weakness. The stock was a 1% position in the fund at 2013’s year-end. In 2013, Experian was up 13.7%, 16.7% including dividends. In 2014, we expect 4% revenue growth and 8% profit and free-cash-flow growth.
04 Tyler Hewlett
BMO Asset Management
Tricon Capital Corp
The 26-year-old Toronto-based real estate firm has been purchasing single-family houses in U.S. markets such as California, Arizona, southeast Florida, Georgia and North Carolina.
It buys at distressed prices, and rents houses at double-digit gross yields. For instance, the company bought houses in Sacramento for less than $100,000 rehabbed, and then rented them for 12% yield. It currently owns about 3,000 houses and plans to get to 4,000 over the next year.
Near the end of Feb. 2014, the share price was $7.88, and the stock had returned 19.3% over the last year. It could go up by at least 30% over the next 12 months. We expect cash flow from land development to be significant compared with the company’s market cap. Given that the company trades at about 1.3 times book value, 1.6 times would account for their business mix and growth opportunities.
Any price weakness triggered by a rise in interest rates affecting the U.S. housing market would likely result in us purchasing more.
Amaya Gaming Group Inc.
Amaya’s systems allow gamblers to play across a variety of platforms—online, physical and mobile—which are currently separate. The major opportunity over the next year is the legalization of online gaming, including poker and casino games across the U.S. and Canada. That’s created opportunities for Amaya to provide services to land-based gaming companies such as Caesar’s, which don’t have online expertise. We expect the stock to appreciate as the company starts realizing revenues associated with these strategic partnerships, and as large states enact regulation to legalize online gaming. By February’s end the stock was almost $9, up about 73% over the last year.
Each manager’s sector and geographic picks:
Dennis Mitchell, executive VP & chief investment officer, Sentry Investments
I like Europe right now. We see the potential for material multiple expansion and robust earnings growth out of European equities for several years to come and we’re actively purchasing high-quality European businesses. While concerns over Europe are legitimate, investors should also consider the European Union’s economic output of US$17 trillion exceeds that of the U.S., and of Canada’s US$1.5 trillion. Also, 161 of the Fortune 500 companies are domiciled in the EU, versus 132 in the U.S. and 9 in Canada. Further, the EU is past the peak of austerity, unemployment is bottoming and companies have begun to reinvest in their businesses again, which should generate stronger growth.
David Kunselman, senior portfolio manager, Excel Funds
Consumer discretionary and India. India is undervalued on both a price-to-book and price-to-earnings-multiple compared to historical levels. India is trading at 14.5 times earnings when growth for 2014 is projected at 16%. We believe the consumer discretionary sector both in India and emerging market as a whole will remain an outperformer in 2014 on the back of strong economic growth, increasing urbanization, and rising per capita incomes which are contributing to greater consumption of goods and services.
Bill Booth, portfolio manager, TD International Equity
Consumer staples and emerging markets. One theme that we expect to continue in 2014, which should benefit both Anheuser-Busch In Bev and Experian, is a growing middle-class consumer in emerging markets, with rising disposable income and access to credit. Global consumer companies that generate a significant portion of their revenue from emerging economies are a good way to invest in this trend without the same risks associated with direct investments in emerging stock markets.
Tyler Hewlett, portfolio manager, BMO Canadian Small Cap Equity
Technology and Canada. We believe that the gains in the tech sector will continue. These companies were starved of capital for much of the past decade. New access to capital and robust end markets should allow tech stocks to continue to grow faster than the overall market.
Originally published in Advisor's Edge Report
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