OB Report
November 2020
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Upside-Down Dinner

Murray Leith By Murray Leith CFA, Executive Vice President & Director, Investment Research

image1_researchIn the Leith household, we sometimes turn dinner on its head and start with dessert. You might think it’s my boys driving that bus, but it was actually initiated by their sweets-loving father.

Our tradition of “not saving the best for last” came to mind when thinking about the 2021 Odlum Brown Annual Address. The live Q&A period at the end of the presentation is always my favourite part, but sadly that won’t be possible this February. Because of COVID-19, the event will be virtual. We toyed with the idea of fielding questions via chat during a live-streamed event, but that’s a bit like trying to enjoy a salted-caramel ice cream cone without actually eating it. I’ve participated in enough large-group webinars to know that typed-in questions are a far cry from the connection and energy that exists when people are together in the same room.

Hence, we are building this year’s event by asking for “dessert” first. We’d like to get your thoughts and questions in advance and ask that you share what’s on your mind with your Odlum Brown Investment Advisor or Portfolio Manager. We will look for common themes and will do our best to provide useful insights. Thank you for entertaining this approach, and we look forward to when we can again meet face-to-face.

Odlum Brown Model Portfolio – Investing Cash

A little more than a year ago, we sold a number of stocks and raised the cash weighting in our Odlum Brown Model Portfolio1 to 13.5%. We didn’t make this unprecedented move because we were worried about the near-term outlook. At the time, we expected the economy to strengthen and for stocks to do well. Rather, we were cautious regarding the medium term and the limited or complicated policy options available during the next inevitable recession. We were also less enthusiastic about the risk and return attributes of the stocks in our investment universe, and our ability to effectively reduce risk through diversification. The same considerations subsequently motivated us to invest nearly half of the newly raised cash in gold.

Having cash and gold in the Model cushioned the financial pain in the early days of the pandemic, but the cash has been a drag on performance during the robust recovery. We are reinvesting the cash in the portfolio because the economic outlook has changed and relative valuations in the equity market have improved. Our cash weighting is now 3%.

A year ago, we worried about how central banks, and governments in particular, would react during the next recession. With interest rates already ultra-low, and negative in Japan and much of Europe, we felt monetary policy would be much less effective at jumpstarting economies. Instead, the world would need governments to get the economy going with stimulative fiscal policies. We fretted that this could be a problem, given the divided nature of politics.  

The pandemic and the authorities’ response to it have altered our thinking regarding the need for cash in an equity portfolio. We are no longer worried about a recession and are instead focused on the pace and magnitude of the recovery. Governments and central banks reacted to the crisis with unprecedented speed and force. On the monetary front, the interest rate relief and the scale of the liquidity injected into capital markets have been well beyond our imagination. Bipartisanship within governments was solid in the early months of the crisis, with politicians of all persuasions embracing a “whatever it takes” attitude to beat the virus and save the economy. Although the political squabbling over the evolution of policy has intensified recently, especially in the U.S., the odds remain good that governments will keep the fiscal pumps primed. While the politics around the U.S. election have slowed progress toward their next round of stimulus, there is sure to be another dose of meaningful aid soon.

The U.S. Federal Reserve is committed to keeping interest rates low for an extended period and letting the economy run hot, with inflation above the targeted 2%, rather than risk an economic relapse. Not only are the extremely low levels of interest rates helping important interest-rate-sensitive parts of the economy like housing, but they also have a positive influence on the value of risk assets.

Against the improved economic backdrop, we increasingly feel there are opportunities to hedge portfolio risks by diversifying with stocks that have relatively attractive risk and returns characteristics. As such, we added five new names to the Model over the last three months: Fiserv, Granite Real Estate Investment Trust (REIT), Stryker, Algonquin Power and Utilities, and CCL Industries.

Fiserv is a leading technology provider for banks and credit unions, with services like account processing, bill payments, digital banking and many other core banking functions. It also processes card and electronic payments for merchants worldwide. The company generates very attractive profit margins and free cash flow, thanks to its scale and discipline. Nonetheless, the stock has lagged the S&P 500 Index in 2020 due to investor concerns about the business’s economic sensitivity. We see this as an opportunity and believe Fiserv’s competitive position and growth potential are solid, especially given their clients’ ongoing need to adapt to a more digital world.

Granite REIT is a logistics-focused industrial REIT, with over 44 million square feet of leasable area at 90 properties, in nine countries. Approximately 40% of rent comes from its single-largest tenant, Magna, under long-term leases. Importantly, Granite continues to diversify its tenant base with other companies like Amazon, Wayfair and Walmart. It is among the most conservatively financed real estate companies in Canada, and its global portfolio enables it to focus on acquisitions in the U.S. and Europe, where opportunities are more compelling. Moreover, the REIT is committed to returning capital to unitholders through dividend increases, special dividends and share repurchases.

Stryker is one of the leading makers of orthopedic products, such as hip and knee-joint implants. It is also a major supplier of endoscopes, emergency medical equipment, intensive care disposable products and patient handling beds. The company has an impressive corporate culture and an enviable record of growth and profitability. Key competitive advantages include: a trusted brand that reinforces strong and lasting relationships with surgeons, a top-notch sales force and significant market share. The pandemic created an opportunity to buy this great business at a discount, as the shares sold off because elective surgeries were curtailed. These surgeries are necessary for patients and are a critical driver of a hospital’s financial health. As hospitals bring elective surgeries back and demand for Stryker’s products returns to normal, the stock should resume its growth path.

Algonquin Power and Utilities owns premier utilities and renewable power generation, mostly in North America. The company has aggressively invested in its asset base over the last decade, which has steadily improved the quality of its business. This has supported a nearly threefold increase in the annual dividend, which we expect to continue to grow. While safe and secure utilities remain the core business, renewable power should grow as demand for green alternatives accelerates. The company is well positioned for this because of its expertise in building wind and solar facilities and its strong relationships with companies like Facebook and Chevron who wish to reduce their environmental footprint.

CCL Industries is a global leader in specialty labels and security and packaging solutions, with 180 facilities in 42 countries. We believe it can grow earnings at an above-average rate due to market share gains and value-accretive acquisitions. The global label market is highly fragmented, and CCL’s size is an advantage versus smaller, regional competitors. With a substantial geographic footprint, multi-national customers are able to leverage the company’s network and consolidate their supply chain. Management has also proven adept at allocating capital and creating shareholder value.

1The Odlum Brown Model Portfolio is an all-equity portfolio that was established by the Odlum Brown Equity Research Department on December 15, 1994, with a hypothetical investment of $250,000. It showcases how we believe individual security recommendations may be used within the context of a client portfolio. The Model also provides a basis with which to measure the quality of our advice and the effectiveness of our disciplined investment strategy. Trades are made using the closing price on the day a change is announced. Performance figures do not include any allowance for fees. Past performance is not indicative of future performance.

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