U.S. equity roundtable: Part 3

Value managers' picks in consumer stocks, health care and industrials

Sonita Horvitch 14 December, 2012 | 7:00PM
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Editor's note: This week's coverage of our U.S. equity roundtable concludes today with strategies and stock picks in the consumer, health-care and industrial sectors. The three-part series was produced by Morningstar columnist Sonita Horvitch, who moderated the wide-ranging discussion. The panellists:

 Janet Navon, managing director, director of research and member of the U.S. investment team at New-York-based Epoch Investment Partners, Inc. Epoch's mandates include managing assets for Toronto-based CI Investments Inc.

 Darren McKiernan,vice-president and portfolio manager at Invesco Canada Ltd.

Glenn Fortin, a portfolio manager with the global equity team at Beutel Goodman & Co. Ltd.

Q: Time to talk about the consumer-staples sector at 11% of the S&P 500 Index and the consumer-discretionary sector at 11.4%.

Fortin: Many staples stocks are not cheap. But we like the sector, given the stability of the companies' cash flow.

McKiernan: Some staples and discretionary stocks are more expensive than they were three years ago. But given the quality of their businesses and their historic valuations, they are reasonably valued.

Fortin: We had a big position in Kraft Foods Inc. before it split its businesses in early October. We ended up owning both Mondelez International Inc. MDLZ, which holds its global snack brands, and Kraft Foods Group Inc. KRFT, which owns its North American grocery business. We continue to own both stocks, but have a larger position in Kraft Foods Group. This company, which dominates its market, has significant scope to improve its margins. It also pays an attractive dividend. The yield is 4.5%. The downside on the stock is limited. It's a three-to-five-year story.

Our other big weight in the U.S. portfolio is CVS Caremark Corp. CVS, a long-term position. The stock reached our target earlier in the year and we sold one third of the position. But we still own it. It has considerable opportunities in the pharmacy-benefits-management business, and it's one of the best U.S. drug store chains.

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Darren McKiernan

Navon: We haven't been enthusiastic about consumer staples, based on valuation. But we have bought PepsiCo Inc. PEP.

McKiernan: I also own PepsiCo.

Navon: PepsiCo has both a snacks and a beverages business. It's been lagging in the latter. We think that it'll rectify that or be forced into valuation creation by separating the two businesses.

McKiernan: An activist investor has taken a position in PepsiCo. Its snack business, Frito-Lay, is one of the best in the world. It has issues on the drinks side, but being number two in the cola business is still good. Something will happen in its beverage business.

In consumer staples, I own tobacco stocks. I have a major holding in Altria Group Inc. MO and I also own Philip Morris International Inc. PM. These companies know that they're not in growth businesses, and they've been good at returning a big percentage of their cash flow to shareholders.

Q: Consumer discretionary?

McKiernan: A big holding is The Walt Disney Co. DIS. It has a good stable of brands that it can leverage through multiple platforms. It recently bought Lucasfilm and obtained the Star Wars franchise. Two-thirds of Disney's profits come from the sports channel ESPN.

In retailing, I own McDonald's Corp. MCD, a long-term holding.

Navon: We also own McDonald's. It's a fairly recent addition. Our biggest holding in this sector is Comcast Corp. CMSCA, a cable and high-speed-Internet provider.

Fortin: We used to have quite a large position in Comcast. But we've been trimming it in recent months. Our largest position in this sector is auto-parts company TRW Automotive Holdings Corp. TRW. The stock is cheap. Its auto-parts are more skewed to the safety side of the business, which has secular growth prospects.

Comcast Corp. McDonald's Corp. PepsiCo Inc.
Dec. 13 close $35.78 $89.17 $70.21
52-week high/low $36.90-$22.56 $102.22-$83.31 $73.66-$62.15
Market cap $94.2 billion $89.7 billion $108.4 billion
Total % return 1Y* 57.9 -6.1 12.5
Total % return 3Y* 30.2 16.2 7.6
Total % return 5Y* 15.9 10.3 0.3
*As of Dec. 13, 2012
All figures $US
Source: Morningstar

Navon: In retailing, we trimmed our holding in discounter TJX Cos. Inc. TJX and put some of the proceeds into department store chain Kohl's Corp. KSS.

Fortin: We own a big position in Kohl's.

Q: Health care, which is 12.15% of the S&P 500 Index?

Fortin: It's a sector with high barriers to entry and strong cash flow.

Glenn Fortin

Navon: This sector is inexpensive if you think about the managed-care stocks. But the pharmaceutical stocks are overvalued. It's a bifurcated sector.

Fortin: There's good value in the medical-device stocks. A major and long-time health-care holding in Beutel Goodman American Equity is Johnson & Johnson Inc. JNJ. Over the next three years, all three of JNJ's divisions -- medical devices, consumer health and pharmaceuticals, which has an attractive pipeline -- should be hitting their stride. This could produce growth rates well above the sector average. It's a well diversified company.

We try not to own companies that have too concentrated a product base. This is one reason why we don't own Abbott Laboratories ABT. Its Humira treatment is getting to be such a big part of the company.

McKiernan: Abbott is in the top 10 holdings of Trimark Global Fundamental Equity.

Navon: It's in the top 10 holdings of CI American Value. Abbott makes both devices and drugs. Coming Jan. 1, 2013, it expects to split the company between the devices business and the drug company. What has hurt the company's valuation is that its auto-immune drug, Humira, is such an important drug for it. You have a drug-expiry valuation on a business that's much stronger. This split is value realization.

McKiernan: Besides its device business, Abbott has its great diagnostic business and its nutritional franchise. This has organic growth opportunities. The split has been known for a long time. Barring any move in valuation, I plan to hold onto both companies, Abbott and AbbVie Inc., which will trade under the ticker ABBV/NYSE. AbbVie will hold almost all Abbott's pharmaceutical business including Humira. This drug faces a patent expiration in several years.

Besides Abbott, we also own Becton, Dickinson and Co. BD, which has a good diagnostic business as well as manufacturing syringes and needles.

Fortin: In this sector, we also own Pfizer Inc. PFE. We sold one third of our position earlier this year. Pfizer is in the midst of realizing value by selling parts of its business. For example, it sold its nutrition business to Nestlé SA. It's spinning out its animal-health business. We prefer health-care companies that create value through products versus facilities or managed-care companies.

Janet Navon

Navon: This is where we differ. We like managed-care companies. They'll be well positioned whether the United States has The Affordable Care Act, better known as Obamacare, or not. Any decrease in margin will be made up for by broader participation. We own both Aetna Inc. AET and UnitedHealth Group Inc. UNH. United is the better business, but Aetna is more attractively valued. These businesses will become more likely a utility.

Q: Industrials, which is 10.1% of the S&P 500 Index?

Fortin: This is a big catchment area. It's undervalued. It's the biggest weighting in Beutel Goodman American Equity at almost 20%.

Navon: It represents around 10% of CI American Value. There's a wide range of companies in this sector, but as a sector it has become cheaper with the lack of global GDP visibility. Our largest industrial is Boeing Co. BA. We're big believers in a prolonged new aircraft cycle. There's the emerging-market demand along with the need to replace aircrafts to gain energy efficiency. In recent years, Boeing has spent a lot of cash flow on development. Now is the payoff.

Fortin: We own United Technologies Corp. UTX, which owns aerospace manufacturer Pratt & Whitney. UTX is not a big position for us. It's a long-term holding.

McKiernan: Lockheed Martin Corp. LMT is my biggest aerospace/industrial holding. It's the largest defence contractor in the world. It has a good dividend-payout philosophy.

Fortin: Our largest position in industrials is railway company CSX Corp. CSX. We like the rails. The players have good pricing power. They're seeing improving profitability.

McKiernan: It's an oligopoly.

Fortin: In general, the lack of corporate spending hits industrials the hardest.

Navon: This provides opportunities. The key to investing in industrials is to find those companies where there's pent-up demand for their products.

McKiernan: The industrial stocks are trading like deep cyclical stocks and I wouldn't consider them to be so.

Fortin: At the end of the third quarter, the industrial-sector weight in the S&P 500 Index was less than 10%, which is a historically low weighting.

Photos: www.paullawrencephotography.com

Complete coverage of Morningstar's U.S. equity manager roundtable

  •  Part 1: Views from the cliff's edge

  •  Part 2: Value managers say tech stocks look cheap

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Sonita Horvitch

Sonita Horvitch  

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