Health- care and consumer stocks a big part of new fund
Darren Lekkerkerker has been managing the equity portion of the Fidelity Canadian Balanced Fund since 2007, and he also runs the materials portion of the Fidelity Global Natural Resources Fund. But now the Toronto- based portfolio manager at Fidelity Investments has the opportunity to build a fund from scratch.
That portfolio, the Fidelity North American Equity Class, launched last week and Lekkerkerker hopes to match or exceed the 16.8- percent annualized three- year return he’s produced for his part of the balanced fund.
Given that he’s currently more bullish on the U. S. than Canada, owing to the former’s better economic strength and lower exposure to resources, Lekkerkerker plans to take advantage of the North American fund’s increased flexibility. It has the ability to go up to a 90- per- cent U. S. weighting, and it has a cap of 20 per cent on other international exposure.
That’s an attractive feature given that performance can swing back and forth in favour of Canadian and U. S. equities. For now, Lekkerkerker expects the new fund will have about 70 per cent exposure to the U. S. and 30 per cent to Canada.
One large holding already in the balanced fund is Restaurant Brands International Inc., the operator of both Tim Hortons and Burger King, which has many of the attributes Lekkerkerker looks for when selecting names for his portfolios.
“It’s a great business with strong brands, pricing power and very high margins,” he said. “Because it’s a franchise model, it requires little to no capital to grow.”
As a result, Restaurant Brands boasts a very high return on invested capital and generates a lot of free cash flow.
It’s run by majority- owner 3G Capital, which Lekkerkerker noted means it’s highly aligned with shareholders and it also has a very strong track record of capital allocation. That was evident following its purchase of Burger King in 2010, as well as when it led the acquisitions of Anheuser- Busch InBev and H. J. Heinz Co.
Lekkerkerker is rather optimistic about consumer stocks — both staples and discretionary — in general, despite being primarily a bottom- up investor. That’s because there are many strong businesses in these sectors that meet the attributes he is looking for, which also include a reasonable valuation based on free cash flow yield, as opposed to GAAP earnings per share.
“We are in the middle or later stages of the market cycle, when these businesses should perform well,” he said. “You can still get reasonable top- line growth, which has been pretty elusive throughout most of the economy and companies we cover.”
He also sees opportunities in these sectors for capital allocation that can enhance shareholder returns, either by using excess free cash flow to buy back stock, or acquire competitors and operate the combined company more efficiently.
Another fund holding, CVS Health Corp., fits this mold. It benefits from structural growth drivers such as the rising demand for drugs from the aging population, but it is also making important moves in terms of capital allocation.
Earlier this year, it bought nursing home pharmacy Omnicare Inc. for US$ 12.7 billion, and also the drug stores in Target Corp.’ s U. S. locations.
“They can make these purchases and immediately add profitability by using their purchasing power,” Lekkerkerker said.
“These are good transactions that will bring higher returns for shareholders at a reasonable price.”
CVS has also engaged in a joint venture with drug distributor Cardinal Health Inc. to combine their purchases of generic drugs to extract a larger discount from manufacturers, which is generating higher margins.
Lekkerkerker thinks there is the “hero” way to play the attractive growth prospects of market segments such as new specialty drugs for treating hepatitis C or cancer, but points out that way creates a lot of risk to shareholders. “A really low risk way to play it is through a company like CVS.”
Thermo Fisher Scientific Inc. also offers investors some defensive attributes since it is a life sciences tool manufacturer that sells into laboratories, academic institutions, governments and biotech firms, but it also has industrial applications.
“Their end markets are showing reasonable organic growth, and management has been really strong taking costs out of the business,” Lekkerkerker said.
He noted that management has successfully boosted margins in the past couple of years, but there is more room to go, particularly given that there are further synergies and cross- selling opportunities to be had from the US$ 13.6- billion Life Technologies Corp. acquisition that was completed in February 2014.