Caution advised on defensive stocks

In general, says Ivory, "earnings growth has slowed substantially from a robust pace in 2011 to a minimal rate in 2012, and this is expected to persist in 2013."

The S&P 500 Index, for example, produced an increase in earnings per share (EPS) of 18% in 2011, "but this dwindled to a mere 2% increase in 2012." Earnings estimates call for an increase of 3% in 2013, "yet the U.S. equity market has been on a tear since the beginning of this year."

Investor enthusiasm for dividend-paying stocks is, in large measure, being driven by the historically low interest rates on fixed-income securities, says Ivory. "This reflects the stimulus policies by many leading central banks, with the Bank of Japan being the latest central bank to introduce an aggressive quantitative-easing policy." The Japanese equity market, says Ivory, is the strongest performer by far of the developed economies' stock markets in the year to date.

At Beutel Goodman, the global equity team is responsible for $2.5 billion in assets. Among the team's mandates are Beutel Goodman World Focus (of which Ivory is the lead manager) and Beutel Goodman American Equity.

Gavin Ivory

Beutel Goodman World Focus, which has 32 names, is benchmarked against the MSCI World Index, the developed-market index. At the end of April, the fund had underweight exposure to the United States and an overweight in Continental Europe and the United Kingdom. Another underweight position was Japan.

Ivory notes that the global team moved to an underweight position in the United States on the basis of valuation. "There was more value to be had in Europe and the UK," he says. "Our emphasis in Europe is on the mid-to-smaller-cap names."

The global equity team, he says, has been finding value in a few select defensive big-cap stocks. An example in the health-care sector is the U.S.-based pharmaceutical giant, Merck & Co. MRK. This stock is in both Beutel Goodman World Focus and Beutel Goodman American Equity.

The global pharmaceutical industry is at the tail end of a wave of patent expirations, says Ivory. The end of this challenge is in sight for Merck, he says. The company has lost patent protection for its asthma treatment drug Singulair, but it is working on new product launches, he says.

Merck's operating margins and cash-flow return on capital bottomed in 2009 and they have recovered sharply since, says Ivory. "This is only now being recognized by investors." The company has "a solid balance sheet and is a strong free-cash-­flow generator." There is also the possibility that "Merck could spin off its animal-health and consumer-products divisions to surface value." The stock trades at 11.3 times 2014 earnings-per-share estimates and has a dividend yield of 4%.

A long-standing pharmaceutical holding in Beutel Goodman World Focus is Sanofi SA, which is based in France. This stock, says Ivory, "has had a good run and is approaching our target price, when our discipline is to sell one third of our holding." Sanofi has an American Depository Receipt, which trades on New York under the ticker SNY.

		Merck & Co.	Sanofi SA (ADR)
	May 20 close	$45.21	$53.84
	52-week high/low	$48.79-$37.02	$55.77-$33.03
	Market cap	$137.1 billion	$145.9 billion
	Total % return 1Y*	24.0%	61.3%
	Total % return 3Y*	16.3%	25.8%
	Total % return 5Y*	6.0%	10.2%
	*As of May 20, 2013. All figures in $US Source: Morningstar

In the financial sector, a recent addition to Beutel Goodman World Focus is Germany-based Deutsche Boerse AG, one of the world's largest securities-exchange companies and a major player in the derivatives market in Europe. "There are high barriers to entry in the securities-exchange business, which is essentially a volume business," says Ivory.

The low market volumes since the global financial crisis have, he says, put pressure on Deutsche Boerse's valuation. The stock trades at 10.8 times 2014 EPS estimates and has a dividend yield of 4.7%. The dividend-payout ratio is high at 40% to 60%, as "the capital requirements in this business are low."

An increase in market volumes "should improve Deutsche Boerse's valuation and allow for an increase in dividends." This, says Ivory, is in contrast to some of the more defensive names, where there is less scope for the companies to raise their dividends in the medium term.

JP Morgan Chase & Co. JPM will also benefit from an improvement in capital-market volumes, says Ivory. This stock is a major holding in both Beutel Goodman World Focus and Beutel Goodman American Equity. "The retail-banking side of JP Morgan is doing well. Its residential mortgage business is improving with the strengthening of the housing market."

From Beutel Goodman World Focus, Ivory sold his holding in HSBC Holdings PLC, which has an ADR and trades in New York under the ticker HBC. "The stock has had a good run and met our target value, so we sold the entire holding." It was, he says, "a good bank to hold during the global financial crisis, given its solid credit quality."

In the consumer-discretionary sector, a Belgium-based mid-cap auto-parts company that Ivory likes is D'Ieteren SA. This company is "a worldwide leader in the vehicle-glass replacement and repair business," he says. The company is a consolidator in this field and is "the number-one operator in every country in which it operates."

D'Ieteren works closely with the property and casualty insurance companies in its different markets, which reinforces its market dominance." The company also distributes a wide range of motor vehicles in Belgium including those from the Volkswagen Group, "a great cash-flow generator for the company." D'Ieteren has a strong balance sheet. The stock trades at a P/E multiple on 2014 EPS estimates of 11 times, and has a dividend yield of 2.2%.