Values emerge in U.S. large-caps

Technology companies will benefit from pent-up demand, says Epoch's Janet Navon.

Sonita Horvitch 30 March, 2011 | 6:00PM
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Janet Navon, managing director at New York-based Epoch Investment Partners Inc., says that U.S. big-cap stocks, which have lagged their smaller-cap counterparts, offer better relative value and generally represent an attractive segment of the U.S. equity market.

"We are bottom-up stock pickers with a value bias, and a number of the small-cap stocks in the portfolios have been reaching our price targets," says Navon, who is the firm's director of research and a member of its U.S. investment team.

The outlook for U.S. bigger-caps, particularly those that are strong cash-flow generators, is promising, she says. It also helps if the companies enjoy some pricing power. "Many firms are facing higher input costs due to inflationary pressures in emerging economies, so it helps their profit margins if they can pass these on to their customers."

Of the U.S. equity market, Navon notes that it started the year on a strong note, "but it has given back some of its gains since." This is "not surprising," she says, given the challenges to the global economy from political uprisings in North Africa and in the Middle East, as well as the European sovereign-debt problems. "What is surprising is that the U.S. equity market has held up so well in the face of these uncertainties; my concern is that all of these risks have not been fully priced in."

On the home front, Navon says that the U.S. consumer has been generally holding up well. But rising energy and food costs could dampen discretionary spending. "We have, for some time, been favouring those retailers that offer customers good value for their money."

U.S. businesses, say Navon, "are flush with cash and are starting to spend." There is substantial pent-up demand for technology, which will benefit a range of information-technology companies, she says. This sector has, for some time, been an emphasis of Epoch's U.S. equity team.

In all, Epoch has US$15 billion in assets under management. Its mandates include managing some $2.5 billion in assets for Toronto-based CI Investments Inc. Epoch is responsible for such high-profile funds as CI American Value   ($353 million) and CI American Value Corporate Class ($372 million).

The focus in these funds is on high-quality, mainly large-cap names, and turnover is low, says Navon. At the end of February, the two largest sector weightings in the portfolio, which has 40 to 60 names, were financial services at 22% and information technology at 19%.

Janet Navon

The U.S. equity team targets strong businesses generating a high degree of reliable cash flow, and run by management teams with a solid track record of allocating capital to enhance shareholder value. Part of its analysis involves establishing a price target on the stock three years out, based on future estimated cash flow.

Epoch's U.S. team recently established a position in the global technology player, Applied Materials Inc. AMAT. The company provides manufacturing equipment to the semiconductor industry.

"Semiconductor manufacturers have not spent on new equipment for some time," says Navon. Applied Materials "will be generating accelerating cash flow," she says, and is likely to enjoy "a prolonged demand for its products and services in this semiconductor cycle."

The biggest technology holding in the portfolio is the global software giant Microsoft Corp. MSFT. Investors have been overlooking its many strengths, Navon says, including its strong relationships with business. "Also, the company has introduced a new operating system, a new office suite and long-awaited new servers."

Microsoft stands to benefit as businesses upgrade their information-technology systems, she says. "Microsoft is a huge cash-flow generator, the stock is reasonably valued relative to the company's growth prospects, and it has a dividend yield of 2.5%."

In the consumer-discretionary sector, a department store chain's stock that the team recently added to the portfolio is Kohl's Corp. KSS. "This chain offers shoppers good value for money," says Navon.

The company has a distinct advantage over some of its rivals, she says, "in that it has most of its stores in locations other than shopping malls." Shopping malls in the United States are generally having a tough time competing for tight consumer-discretionary spending dollars, she adds.

In the financial-services sector, Epoch's focus continues to be on non-bank financials, as it was in mid-2010. The portfolio's largest financial holding is Ameriprise Financial Inc. AMP, which is also in its top 10 holdings. Ameriprise (formerly American Express Financial Inc.) offers financial-planning advice and wealth-management services, asset-management services, annuities and other insurance products.

Applied Materials Inc.

Kohl's Corp.
March. 29 close $15.70 $53.04
52-week high/low $16.93-$10.27 $58.99-$44.07
Market cap $20.7 billion $15.4 billion
Total % return 3Y* -5.5% 8.0%
Total % return 5Y* -0.8% 0.2%
Total % return 10Y* -2.9% -1.4%
*As of March 29, 2011
All figures US$
Source: Morningstar

"Ameriprise has made some significant acquisitions in the asset-management industry, and is also successful in attracting assets," says Navon, who notes that there are considerable economies of scale in this business. "The company is a strong cash-flow generator; the stock is reasonably valued and has a dividend yield of 1.25%."

Energy, at 12%, is a sizeable weighting in the portfolio. A producer that has properties "in our own backyard" that offers value, she says, is Devon Energy Corp. DVN. Devon "has sold off its international and offshore U.S. interests."

The company is concentrating on its onshore natural-gas and oil exploration and production in the United States and Canada -- where it has a good portfolio of oil-sands projects in Western Canada. "The stock price does not reflect the value that will accrue when Devon deploys the proceeds of its asset sales," Navon says.

The Epoch U.S. equity team is generally unenthusiastic about the materials sector, says Navon. "The valuations in this sector are high and the companies are selling to emerging economies like China, India and Brazil, which are applying the brakes to their economies to curb inflationary pressures."

The team recently sold its holding in The Mosaic Co. MOS, which is one of the world's leading producers of concentrated phosphate and potash nutrients. "It was a matter of valuation; the stock was fully priced." Also, she says, the commodities' prices have risen to such heights that there is an incentive to reduce their use.

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Sonita Horvitch

Sonita Horvitch  

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