U.S. equities roundtable: Bets on increased spending

TJX's eye-catching cash flow. Cheers for Yahoo! Garbage profits. And more

Sonita Horvitch 29 October, 2010 | 6:00PM

Editor's note: We conclude this week's U.S. equities roundtable with a wide-ranging discussion of the managers' picks in the consumer, technology, industrials and health-care sectors. Our panellists: Brad Willock, vice-president and senior portfolio manager, U.S. equities, at Toronto-based RBC Global Asset Management; Janet Navon, managing director, director of research and a member of the U.S. investment team at New York-based Epoch Investment Partners Inc., whose clients include CI Investments Inc.; and Gavin Ivory, vice-president, global equities, and head of the global equity team at Toronto-based Beutel Goodman & Co. Ltd. They spoke with Morningstar columnist Sonita Horvitch, whose three-part series began on Monday and continued on Wednesday.

Q: Where are the opportunities in U.S. consumer-related stocks?

Navon: The U.S. consumer has been remarkably resilient. College-educated unemployment is at 4.7% versus the overall unemployment rate of under 10%. This explains why some of the retailers are doing quite well, but others like Wal-Mart Stores Inc. WMT are having challenges.

Willock: It estimates that 25% of its typical customers in some states are out of work. We sold the stock.

Navon: We have been fairly defensive in our strategy, but yet not very involved in consumer staples. Consumers are looking for value. One of our favourites is discount retailer TJX Cos. Inc. TJX. It is expanding in Canada and in Northern Europe. TJX has enough free cash flow to repurchase shares on an ongoing basis and a 1.5% dividend yield.

Willock: TJX is in some mandates, including RBC North American Dividend. We do not own it in RBC U.S. Equity  .

Navon: TJX has a good track record of raising the dividend.

Willock: The mandate of RBC North American Dividend is to not only invest in high- dividend-yielding stocks, but to focus on dividend growth and on potential dividend payers. We look at both share buy backs and dividends.

 
Brad Willock: We are generally emphasizing semiconductors and software companies in technology.

Navon: These are components of shareholder yield. A stock in the less cyclical consumer category that we own is Comcast Corp. CMCSA.

Ivory: We own Comcast, and we have added to it significantly in the last couple of months on valuation. We have had a big exposure to consumer staples for years because it suits our style. The companies are stable free-cash-flow generators. We are focusing on the growing health of U.S. consumers. We were recent buyers of Kroger Co. KR, a supermarket chain.

Willock: In RBC U.S. Equity, we are a little underweight staples and overweight discretionary stocks. When we become defensive, we take the money out of discretionary and put it into staples and vice versa. Our biggest holdings in RBC U.S. Equity are Coach Inc. COH, Viacom Inc. VIA.B and Yum! Brands Inc. YUM. The latter's brands include KFC, Pizza Hut and Taco Bell.

Navon: Yum is a play on China.

Q: What are your technology picks?

Willock: U.S. technology companies have outsourced a lot of their manufacturing to Asia, so that their profit margins are at an all-time high. This is likely to persist. The companies had their near-death experience a decade ago. The stocks have underperformed for six or seven years. This is typical after a bubble. Valuations have come down sharply and are now more in line with the market. Of the stocks, Apple Inc. AAPL is at market weight in RBC U.S. Equity. There is a larger weighting in the stock in other mandates, which I manage on my own. We are generally emphasizing semiconductors and software companies in technology. We own Microsoft Corp. MSFT.

Navon: Microsoft is our largest holding in CI American Value  . The company is managing for profitability. Microsoft has a new operating system and we think that businesses are finally ready to spend on upgrading their systems. It is a subscription-based model, so Microsoft does have that recurring revenue stream that we like. The stock is also attractively valued. We more recently added Dell Inc. DELL Businesses are going to want to upgrade their computers with the new 64-bit operating system. Dell has tailwinds too in its sourcing strategy.

 
  Janet Navon: We think that businesses are finally ready to spend on upgrading their operating systems.
 

Another holding is Yahoo! Inc. YHOO. It has an equity stake in Alibaba Group in China and interests in some Japanese enterprises. Because of the accounting rules, these are not included in Yahoo's cash flow. Yahoo could do something to realize value in these holdings.

We have taken some profits in Apple. We keep cutting Apple to below 2% of the portfolio, but it keeps going up. We have owned Apple since 2002.

Willock: Apple should have more than US$60 a share in cash at the end of 2011. The stock is cheap on an earnings basis at 12 times 2011 earnings-per-share estimates, if you take cash out. iPad sales are likely to exceed expectations.

Ivory: We have six technology holdings. The largest is International Business Machines Corp. IBM, which we have held for years. It is transitioning from equipment to consulting. The stock is getting close to our target price, so we have not been adding to it.

The only technology stock that we have been adding to is Cisco Systems Inc. CSCO, a more recent position. Cisco is geared to the recovery in business spending. It is a strong cash-flow generator and has a good balance sheet.

Q: What about industrial companies?

Navon: We have been favouring companies in the aerospace sector. We own Boeing Co. BA and Rockwell Collins Inc. CPL. We have standbys like Praxair Inc. PX, a worldwide provider of industrial gases. A more diversified industrial stock that we own is E.I. du Pont de Nemours & Co. DD. Management has done a fabulous job. The company is creating cutting-edge products, which is giving it pricing power.

Willock: This is a big position in some of the U.S. mandates. The stock has a good dividend yield.

Navon: It is 3.5%.

 
Gavin Ivory: IBM stock is getting close to our target price, so we have not been adding to it.

Willock: We have been selling our holding in Deere & Co. DE and, like Janet, have generally been moving into the aerospace sector.

Navon: We also sold Deere. It met our price objective.

Ivory: There are a lot of great U.S. industrial companies, but valuations are not attractive. The sector has done well. We sold our smaller industrials like Gardner Denver Inc. GDI and Eaton Corp. ETN, earlier this year. These stocks had a good run and have become quite expensive. A bigger-cap that we own is UTX Technologies Corp. UTX. The biggest holding in this area is Waste Management Inc. WM.

Willock: Garbage is a good business.

Q: And the health care sector?

Ivory: The companies are great cash-flow generators and dividend payers, but there is concern about future revenues. The equity market continues to undervalue these stocks, based on punitive growth assumptions. The big U.S. pharmaceutical companies are re-invigorating their drug pipelines and/or are making more sensible acquisitions. You need a longer-term view. We have a big holding in pharmaceutical giant Pfizer Inc. PFE. Another big weighting is Covidien Ltd. COV, which makes hospital consumables and some of its own drugs. We also own Zimmer Inc. ZMH, which is a world leader in the manufacture of orthopedic products.

Navon: We are not keen on pharma stocks. The companies have too many drugs coming off patent and the government is not allowing them to make the kind of money they made before.

Willock: We are cautious. There is the issue of government intervention. We have a shorter investment horizon than Gavin.

Ivory: The anti-pharma legislation could change following the November mid-term election.

Navon: There is an anti-incumbent move.

TJX Cos.
Inc.
Wal-Mart
Stores Inc.
Dell Inc. Yahoo! Inc.
Oct. 28 close $46.44 $54.08 $14.59 $16.40
52-week high/low $35.75-$48.50 $47.77-$56.27 $11.34-$17.52 $12.94-$19.12
Market cap $18.7 billion $197.4 billion $28.2 billion $22 billion
Total % return 1Y* 24.2 10.7 0 2.2
Total % return 3Y* 18.5 8.7 -20.5 -21.3
Total % return 5Y* 18.3 5.2 -14.0 -14.4
*As of Oct. 28, 2010. All figures US$
Source: Morningstar

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Sonita Horvitch

Sonita Horvitch