Encounter

Managers applaud financial giants for share buybacks.
By Sonita Horvitch | 24/11/17

Editor's note: This week's coverage of our U.S. equity roundtable concludes today with the managers discussing where they are finding attractive stocks in the financial and consumer sectors.

About the Author
Sonita Horvitch is a Morningstar columnist who specializes in reporting on money managers and their strategies. A veteran financial journalist, she was formerly with the National Post and its predecessor, the Financial Post. At the Post she was best known as the author of the popular Buy & Sell column, which she wrote from its inception in 1994 to December 2008. She holds a master's degree in business economics from the University of the Witwatersrand in Johannesburg, South Africa.

The managers:

David Pearl, executive vice-president and co-chief investment officer at New York-based Epoch Investment Partners, Inc., which manages assets for TD Asset Management Inc. and CI Investments Inc. Funds managed include Epoch U.S. Large-Cap Value under the TD banner, and CI American Value.

Jonathan Norwood, senior vice-president and portfolio manager on the Mackenzie Cundill team at Mackenzie Investments. His mandates include Mackenzie Cundill U.S. Class.

Jim Young, vice-president at Invesco Canada Ltd. He is responsible for Trimark U.S. Companies and Trimark U.S. Companies Class.

Glenn Fortin, vice-president at Beutel Goodman & Co. Ltd. A specialist in U.S. equities, Fortin is a member of the firm's U.S. and global equity team. Its mandates include Beutel Goodman American Equity.

The roundtable, which began on Monday and continued on Wednesday, was convened and moderated by Sonita Horvitch.


Q: Continuing our discussion of the U.S. health-care sector: Jonathan, your holdings?

Norwood: We like  DaVita Inc. (DVA), which provides kidney dialysis services. This is an excellent business. DaVita operates in an oligopoly. It is a big free-cash-flow-generating company. It does not pay a dividend, but it does buy back a lot of its stock. The stock is inexpensive.

David Pearl
David Pearl

Fortin: One of our biggest health-care holdings is drug distributor  AmerisourceBergen Corp. (ABC). It operates in an oligopoly. It is a scalable business and the company generates significant amounts of free cash flow. There are good returns of cash to shareholders in the form of dividends and share buybacks.

Q: Financials represented 14.7% of the S&P 500 Index, at the end of October. The sector produced a total return of 15.8% in the first 10 months of 2017. Jonathan, you have a large number of financial stocks in your top-10 holdings.

Norwood: Our thesis on the U.S. banks is that  Bank of America Corp. (BAC) and  Citigroup Inc. (C) are trading at roughly book value. They have substantially improved their financial profiles, with strong balance sheets. Rising interest rates will be a tailwind for the banks. The U.S. banks are buying back a lot of their stock and at low valuations. This is powerful.

Another holding in the fund is the global insurer  American International Group Inc. (AIG). The company is not buying back as much of its stock as it did a year ago. It has new management under the helm of the new CEO, Brian Duperreault. AIG has a lot of legacy issues. More recently, it suffered substantial losses due to the devastation from the hurricane season. On the plus side, the sum of the parts of the company is worth more than the current share price. Also, rising interest rates will be a tailwind.

Jonathan Norwood
Jonathan Norwood

Pearl: I also own Bank of America and AIG. In the case of AIG, our preference would have been that the company buy back more of its stock. The jury is out whether management will use the cash for a higher return to shareholders or not. The stock is undeniably cheap. We are overweight in financials and we have not been so for about a decade. I agree with Jonathan that this is the right time to own most of these stocks. Return of capital is a big deal.

Another significant holding in the portfolio is wealth manager  Morgan Stanley (MS). It has benefited from the rise in short-term interest rates from zero to 1%. It has almost US$1 trillion in money-market funds and can now charge fees for these funds. Bank of America is improving its operations and becoming more competitive. Its brokerage house Merrill Lynch is doing better. Bank of America is buying back stock. Financials should benefit from the stronger economy, rising interest rates, lesser regulation and tax reform.

Fortin: We have less bank exposure in Beutel Goodman American Equity than last year. Our higher-conviction positions are in financial businesses that have less capital intensity, but higher returns. Our two biggest names there are  Ameriprise Financial Inc. (AMP) and  American Express Co. (AXP).

Pearl: I own Ameriprise. As with Morgan Stanley, its business has benefited from the stock market and interest rates going up.

American International Group Inc.Ameriprise Financial, Inc.Bank of America Corp.
Nov. 22 close$59.23$159.58$26.66
52-week high/low$67.47-$57.90$163.04-$109.19$27.98-$20.20
Market cap$53.2 billion$23.6 billion$278.1 billion
Total % return 1Y*-5.543.133.0
Total % return 3Y*4.68.617.0
Total % return 5Y*14.023.523.0
*As of Nov. 22, 2017. All figures in U.S. dollars
Source: Morningstar

Fortin: We bought Ameriprise, as the stock was mispriced. It was being valued as a life insurance company, but it is more of a wealth-management company. It has a great franchise and is building this business. American Express is one of best franchises with respect to corporate and high-end consumer credit cards. It is a high-return business.

Young: Trimark U.S. Companies has significant holdings in  PNC Financial Services Group Inc. (PNC),  JPMorgan Chase & Co. (JPM) and the global property and casualty insurer  Chubb Ltd. (CB). I have owned Chubb for some time. It is a great underwriter and a great capital allocator.

Glenn Fortin
Glenn Fortin

Pearl: We also own Chubb. It is a steady free-cash-flow generator.

Q: Time to discuss consumer-discretionary stocks (11.9% of the S&P 500 Index at the end of October) and consumer staples (7.9%). The discretionary sector had a total return of 14.3% in the first 10 months of 2017, and for the staples it was 5.1%.

Fortin: In the last 12 months, we initiated two new consumer-discretionary names,  Omnicom Group Inc. (OMC) and  AutoZone Inc. (AZO). Omnicom, which provides advertising and marketing services, is one of the most successful brand-building service organizations in the world. It has excellent returns through the cycle and is returning cash to shareholders. AutoZone is a major auto-parts retailer in the United States. "Failure maintenance" parts are about 85% of its sales and when a customer needs the part, the need is immediate. So, AutoZone is less vulnerable to e-commerce. A significant consumer-staples holding is  Kellogg Co. (K). Our thesis on Kellogg is that it is expanding its margins and improving its operations.

Pearl: We consider consumer staples to be expensive. We do not see much value in the entire sector. We do own  Coca-Cola Co. (KO). The thesis is that it is buying back its bottlers, and this will result in a profit-margin improvement. Consumer discretionary should benefit from the good economic backdrop that we have talked about. The challenge is to find those companies that can make money and will not be challenged by Amazon. The newest name in the portfolio is  Dollar General Corp. (DG). Almost 50% of its customers do not have a credit card. If you do not have a credit card, you probably will not have an online account at Amazon. Dollar General is price-competitive against the bigger lower-priced retailers. We also own  The Home Depot Inc. (HD). It is a similar thesis to that of Glenn's on AutoZone. Amazon will not be able to send lumber over the Internet. We also own  Walt Disney Co. (DIS). It is firing on all but one cylinder, its ESPN sports channel, and that is the investment opportunity. Disney is the king of content.

Jim Young
Jim Young

Norwood: An inexpensive consumer-staples stock that we like is  Edgewell Personal Care Co. (EPC), which offers branded products in areas such as shavers, sunscreen, personal hygiene, skin care and baby products. Consumer-product companies that supply traditional retailers have come under pressure.

Young: I have added two names recently in the consumer space. They are  Mondelez International Inc. (MDLZ) and discount retailer  TJX Companies Inc. (TJX).

Pearl: I own TJX. It has had a more difficult year. It is a resilient business and its customer base is loyal.

Young: Mondelez has a large number of strong brands: crackers, cookies, gum and chocolates. Some 80% of its business is overseas, so it is less disrupted by what is going on with brands in America.

Q: Can we sum up our discussion about the valuation of the U.S. equity market?

Young: Valuation multiples are not out of line. We have a U.S. economy that is growing nicely and probably accelerating a little, so the U.S. equity market will move up in line with earnings. This is the second leg of the bull market.

Fortin: There are pockets where there are excess valuations, but there are still opportunities to build positions in high-quality franchises.

Norwood: We are still in the U.S. equity market buying some stocks at 52-week lows. Yes, there is this concern about disruption from Internet-based offerings, but this is providing value opportunities.

Pearl: The market can go higher. The dispersion in the U.S. equity market has increased, which is good for stock picking.

Photos: Paul Lawrence Photography

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