U.S. equity roundtable: Part 2

Managers review some of their favourite household names.

Sonita Horvitch 17 February, 2016 | 6:00PM

Editor's note: In today's second installment of this week's coverage of our U.S. equity roundtable, the managers ponder the prospects for a broad market comeback, and review some of the household names in consumer stocks that they've bought for their portfolios.

Our panellists:

Glenn Fortin, portfolio manager at Beutel Goodman & Co. Ltd. Fortin is a U.S. equity specialist and a member of the firm's global equity team. The team's mandates include Beutel Goodman American Equity.

Michael Mattioli, managing director and portfolio manager at Boston-based Manulife Asset Management (U.S.), LLC. He is a member of the U.S. core-value equity team. The team's mandates include Manulife U.S. All Cap Equity.

Stephen Groff, principal and portfolio manager at Cambridge Global Asset Management, a unit of CI Investments Inc. Groff's roles include lead portfolio manager of CI Cambridge U.S. Dividend and CI Cambridge American Equity.

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

The roundtable was convened and moderated by Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and concludes on Friday.


Q: What could make the U.S. equity market turn?

Groff: The pendulum has swung so far one way. You've not only had investors selling their stocks, but you've also had short positions in the stocks piling on. That can quickly unwind. If you watch stocks with high short interests on days when there's a modest rally in the market, the stocks go up sharply, as investors need to cover their short positions. That can help the market to turn. In some of the cyclical, industrial areas, there are high short positions. Similarly, in a lot of consumer-discretionary companies, such as the retailers, there are high short positions.

Q: Valuations in some areas of the market are attractive. What about the earnings estimates for the U.S. equity market for this year?

Jim Young
Jim Young

Young: Across the board, 2016 looks like a flat year for earnings for the S&P 500 Index.

Groff: Earnings expectations have been coming down and will probably continue to do so. But, at this point, the market is already pricing in a more difficult year.

Young: A good underpinning for the U.S. equity market is that dividend-payout ratios are still very low. A lot of companies are on a path of increasing their dividends regularly.

Q: Let us sum up the big-picture discussion.

Groff: There's a lot of discussion about being a contrarian investor in this type of environment, but it appears that no one is willing to go against the grain, as yet. The seeds are being sown for good returns over time.

Fortin: A time of uncertainty and negative sentiment is when you get your best opportunities to buy great franchises, if you have a long-term time horizon.

Mattioli: The U.S. economy is chugging along. Population is still growing. For the long term, earnings should continue to grow. You can find good value in a number of sub-sectors of the market, right now.

Young: The U.S. equity market remains attractive in the global context. The United States has the strongest business environment and some of the strongest global companies.

Q: Time to briefly discuss your disciplines.

Fortin: Beutel Goodman is a bottom-up value manager. We run concentrated portfolios. There are currently 26 names in Beutel Goodman American Equity. We emphasize free cash flow. We look to identify great franchises and purchase them when they go on sale. We require a 50% total return over three years, at the initiation of the holding. Once the stock reaches our target, we automatically sell one third of the position and re-evaluate the holding.

Young: The focus is on sustainable growth. This is the result of innovation, good execution and reinvestment in the business. The valuation does have to make sense. There are about 40 names in Trimark U.S. Companies.

Stephen Groff and Michael Mattioli
Stephen Groff and Michael Mattioli

Mattioli: We look for companies with sustainable competitive advantages. Important to us is the management team and how it's allocating capital. We do a range of values analysis, assessing what a business is worth in a best case, a base case, a bear case and a worst case set of assumptions. We look to buy the businesses at 70 cents on the dollar on the base-case valuation. We'll trim when the stock approaches 100 cents on the dollar and sell out completely at or over 100 cents on the dollar. We have about 45 names in Manulife U.S. All Cap Equity. We have a minimum five-year investment horizon.

Groff: I have 27 names in Cambridge U.S. Dividend. We focus on quality franchises that generate high returns on invested capital and are good cash-flow generators. Management must be good at capital allocation and its interests must be aligned with those of shareholders. When it comes to when to own them and how much of them to own, we look at the upside and the downside possibilities on the stock. We adjust the weightings in the portfolio according to how the share prices move compared with what we think the businesses are worth.

Q: Time to discuss sectors and stocks. Let's start with consumer-discretionary and consumer-staples stocks.

Groff: A significant consumer-staple holding in Cambridge U.S. Dividend is the global pharmacy-led health and beauty products retailer,  Walgreens Boots Alliance, Inc. (WBA). Walgreens is in the process of acquiring Rite Aid Corp. (RAD), a U.S. retail pharmacy chain. On Oct. 27, last year, Walgreens announced that it would acquire Rite Aid for US$9 a share in cash, for a total enterprise value of US$17.2 billion, including acquired net debt. I also own Rite Aid's stock, which has been trading at a material discount to the acquisition price. I anticipate that the deal will close. (The transaction is scheduled to close in the second half of this year.)

Mattioli: In the consumer-discretionary sector a top-10 holding in Manulife U.S. All Cap Equity is  Amazon.com, Inc. (AMZN). About 8% of all U.S. retail sales are transacted through e-commerce. Depending on the data, Amazon has about 45% of that. If you expect e-commerce, as a percentage of retailing, to grow to say a 16% share over the next 10 years and Amazon maintains or increases its market share, then its revenue-growth outlook is robust. We model Amazon looking out 10 years. We have owned the stock since 2002. We think that it's undervalued, especially at this point.

Another consumer-discretionary holding is  Ralph Lauren Corp. (RL). The stock has been hurt recently, but it's a turnaround play. This is a large global brand and the company has great distribution. Ralph Lauren recently hired a new CEO, Stefan Larsson, formerly the global president of Old Navy, a division of  Gap, Inc. (GPS). In all, we're seeing a lot of value in the consumer-discretionary sector. Among the staples, I own  Procter & Gamble Co. (PG). It has big global distribution and it's continuing to invest cash flow back into its brands. It's a core holding.

Glenn Fortin
Glenn Fortin

Fortin: Procter & Gamble Co. is also in Beutel Goodman American Equity. It's a long-term holding. Another aspect of the P&G story is the costs that it can take out of its system. P&G is a great free-cash-flow generator. David Taylor, a P&G veteran, was appointed CEO last year. New top management breathes new life into how senior management thinks. We also own  Kellogg Co. (K), a cereal and snack manufacturer. Like P&G, it has great assets and great brands that are in the process of being managed better, in terms of addressing costs. It's also a great free-cash-flow generator. Both companies give money back to shareholders in the form of dividends and share buybacks.

Young: A consumer-staple stock that I have owned since the fund started some 17 years ago is  PepsiCo (PEP). Its carbonated soft drinks generate good cash flow and the company has deployed this successfully in other areas, such as snacks. The stock provides good ballast to the portfolio.

I also own  Estée Lauder Cos. Inc. (EL). We added it last year. The stock got down into the US$70s. Estée Lauder has good internal growth, with multiple strong global brands. It has a strong makeup franchise, which is a real driver. Skin care and fragrances are important to the company too. CEO Fabrizio Freda has done a good job.

On the retail side, I own  Lowe's Cos, Inc. (LOW). Lowe's is tied to the housing cycle and it's not as at risk to Internet offerings. It's essentially a warehouse. Builders need its products. It also leads in appliances in the United States. Lowe's is looking to buy Canada's Rona Inc. (RON).

Mattioli: Lowe's is offering to pay a 100% premium on the price that Rona's shares traded at prior to Lowe's takeover bid announcement. We own Lowe's. We like the U.S. housing market. Lowe's has a duopoly with  Home Depot Inc. (HD).

Young: Lowe's trades at a discount to Home Depot. The U.S. housing market continues to strengthen.

Photos: Paul Lawrence Photography

Amazon.com Inc. Estée Lauder Cos. Inc. Lowe's Cos. Inc. Procter & Gamble Co.
Feb. 12 close $507.08 $88.31 $64.87 $80.99
52-week high/low $696.44-$365.65 $91.68-$73.67 $78.13-$62.62 $86.39-$65.02
Market cap $241.8 billion $32.6 billion $61.4 billion $219.7 billion
Total % return 1Y* 34.4 10.4 -8.7 -2.8
Total % return 3Y* 25.2 13.2 19.3 5.3
Total % return 5Y* 21.8 14.4 22.3 7.5
*As of Feb. 12, 2016. All figures in U.S. dollars
Source: Morningstar

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Amazon.com Inc1,817.02 USD-0.30
Gap Inc17.94 USD-1.48
Kellogg Co63.61 USD-0.84
Lowe's Companies Inc112.60 USD-0.12
PepsiCo Inc135.50 USD-0.15
Procter & Gamble Co121.41 USD0.21
Ralph Lauren Corp Class A98.54 USD-0.51
Rite Aid Corp6.90 USD-2.54
The Estee Lauder Companies Inc Class A192.02 USD0.36
The Home Depot Inc230.83 USD0.27
Walgreens Boots Alliance Inc54.41 USD-0.78

About Author

Sonita Horvitch

Sonita Horvitch