Manager cycles back to cyclicals
BUYS ENERGY, MATERIALS AND INDUSTRIALS
It’s a lesson investors have learned the hard way countless times: being too defensive can hurt you. Up until recently, the sharp downturn in commodity prices has caused cyclical areas of the equity market do very poorly, as a lot of bad business models have been uncovered.
At the same time, many of the big and boring businesses in sectors like consumer staples, consumer discretionary and utilities have seen their valuations expand dramatically, even though fundamentals have not been getting better.
That’s prompted Brandon Snow, portfolio manager at Cambridge Global Asset Management, to transition the $ 4- billion Cambridge Canadian Equity Corporate Class toward more cyclical exposure, while at the same time reducing positions in defensive areas.
While the portfolio manager isn’t buying over-levered miners or oil producers, in the past year or so he has increased the fund’s energy weighting to about 10 per cent, its materials exposure to roughly seven per cent, and industrials to approximately 15 per cent of the portfolio.
“We’re trying to be very patient and deliberate as to how much of the cyclical exposure we take on,” Snow said. “We would rather hold cash than boring stocks right now because we think the risk is skewed out of favour on those,” he added, noting that the fund’s cash weighting is about 20 per cent, excluding what is used for derivative strategies.
Consumer- product companies in the U. S. serve as a perfect example of an area where prices are ahead of fundamentals.
Snow noted that valuations have expanded roughly 70 to 80 per cent in the past five years, yet companies face growth challenges, have limited pricing power, and have been beneficiaries of both the rebound in consumer spending and lower commodity prices.
“Even with those benefits, growth hasn’t been tremendous,” Snow said, pointing to earnings- per- share gains of just a couple of per cent annually.
He sees a similar trend playing out in Canada, where great companies like Metro Inc., Alimentation CoucheTard Inc. and Dollarama Inc. have seen their multiples essentially double in the past five years.
“Unless you think the value of the business today is twice what it was five years ago, it’s hard to justify the valuation,” Snow said. “There are a lot of different sub-sec- tors in staples and utilities where we’ve seen a massive move up in multiples, even though fundamentals haven’t changed. There have also been some tailwinds that I don’t think you can extrapolate going forward.”
He has focused on finding very high- quality business models that are discounted because of uncertainty and concerns around the energy, materials, emerging markets space.
One such name is Fin- ning International Inc.
( FTT/ TSX), which Snow has owned for about a year, but added to as recently as February.
“The management team that came in a couple of years ago has really improved the underlying business, and are setting it up very well for when the recovery comes,” Snow said.
What’s interesting about Finning is that its cash flows are actually counter-cyclical. During a downturn such as this, the company basically stops ordering trucks, sells out its inventory, and therefore brings a lot of cash through the door.
So even in these difficult times, Snow thinks Finning may generate $ 300 million or more of free cash flow this year.
Another relatively large holding, Chubb Ltd. ( CB/
NYSE) fits the mould of a large, stable and boring business. But as opposed to some of the defensive areas Snow has been avoiding, this property and casualty insurer has a lot of growth potential that is not being discounted by the market.
“Its valuation has not expanded dramatically over the past five years,” Snow said, highlighting the recent merger with ACE Ltd. and the synergies it will generate. “Over the next three to five years, they will generate a lot of excess capital. That will be used to grow profitably, and if they can’t find those opportunities, they will return the capital to shareholders.”
Brookfield Infrastructure Partners LP (BIP.UN/TSX) is a long-term fund holding, but one Snow thinks hasn’t been this attractive in a long time. That’s largely because of the opportunities the company has due the stress in some of its end markets.
Snow highlighted t he North American energy infrastructure sector and Brazil, where a corruption scandal has engulfed many of the country’s construction companies.
“Cheap government financing and handouts are not there anymore, so a company that knows the industry and has the capital can generate significant returns when there is not a lot of competition,” he said. “They are literally the last man standing in some cases.”