McMurtry Investment Report – April 2024
Also available in PDF: McMurtry Investment Newsletter – April 2024
April 2024 Investment Newsletter
Investment Review of Defensive Equity Sectors- namely Telcos, Consumer Staples, Utilities and Healthcare
Consumer Staples
Prices as of April 3, 2024
The only Consumer Staples stocks on the attached table that outperformed their domestic indices over the last 12 months were Loblaw and Primo Water in Canada. No US Consumer Staples stock on this table outperformed the S&P 500 on a total return basis. However, Walmart and Colgate performed quite well nevertheless.
The headwinds negatively affecting this sector were higher interest rates, slow revenue growth, higher operating costs and declining margins. Cost pressures were so extreme in this group they forced Unilever to divest of its global ice cream business as a result of its poor profitability prospects. Even the large players like Pepsico and Proctor & Gamble are experiencing poor earnings visibility as a result of higher operating costs including labour.
I have decided to delete Alimentation Couche- Tard from both portfolios. As a result of its size, the company is having more and more difficulty making accretive acquisitions that benefit their bottom line. Earnings prospects remain bleak for this company for the year 2024.
I still like Loblaw and Primo Water for their solid earnings visibility. Premium Brands is expected to see a pickup in earnings this year as some of their net income had been deferred until this year. Jamieson is still experiencing growing pains but its earnings and revenues are expected to gradually improve this year with a strong rebound in 2025 as their foray into both the US and China starts to pay off. Monster Beverage remains a solid holding with its strong earnings growth prospects.
TELCOS
I have included the Telcos in my group of defensive sectors. They are actually part of the Communications sector, but that sector is now dominated by companies like Google, Meta and Netflix , all of which are Growth companies.
The telcos were especially hard hit by rising interest rates with their balance sheets more levered than in many other industries. The Canadian telcos had a very poor year as evidenced by their total return numbers over the last year.
To my amazement, many Bay Street money managers continue to recommend BCE despite their ongoing issues. BCE’s free cash flow does not totally cover their dividend and thus they had to borrow to pay for it. This is not sustainable and quite irresponsible in my opinion given their massive layoffs across several industries. Even in the midst of their financial difficulties the company still increased its dividend. This is not only surprising but reckless. As a dividend is generated out of retained earnings, differing from interest expense that is fully tax deductible from the income statement, dividends are more costly than interest expense is.
The outlook for Quebecor still looks promising from its acquisition of Freedom Mobile.
After the Canadian government finally gave the go ahead for Rogers’ acquisition of Shaw, the new combined company can focus on massive cost synergies that will help their earnings outlook. Earnings growth continues to look more favourable for Rogers over both BCE and Telus.
Utility Companies
The only company on this attached table of Utility stocks to outperform its domestic equity index was Altagas with a 35.55% total return over the last 12 months. This was a strong performance in relation to its peers that all registered negative returns, except for Duke Power’s 4.56% return. Industry headwinds included high interest rates and rising operating costs that hurt operating margins.
As a result of poor earnings outlook for Capital Power over the next two years, I am deleting the stock from both portfolios.
I still like Altagas, Brookfield Infrastructure and Brookfield Renewable, Fortis and Nexera in the US. While Emera looks interesting, its long- term track record is not nearly as favourable as is the case with Fortis.
The final defensive equity sector I am reviewing is Healthcare. As our domestic Healthcare sector is dominated by unprofitable cannabis stocks, I am only focusing on US and global companies with ADR’s.
Differing from the other defensive sectors, several Healthcare stocks have outperformed their domestic equity index over the last 12 months. Eli Lilly, Novo Nordisk, and Vertex all outperformed the S&P 500, while Merck and Stryker had respectable returns as well.
Healthcare Companies
In a recent blog, I deleted Elevance, the US private health insurer from both portfolios. This industry is being plagued with poor reimbursement from the government in regards to their Medicare Advantage patients.
I continue to like both Eli Lilly and Novo Nordisk for their diabetes and weight loss drugs. Both Astra Zeneca and Merck look attractive trading at low PE valuations with solid EPS growth prospects from their expanding drug pipelines. Pfizer also looks very reasonably valued at current prices.
In the medical device area, Stryker is finally starting to benefit from a return to non emergency medical procedures after a long lull during Covid.
Conclusion and Recommendation
These defensive sectors continue to face major headwinds like higher interest rates for longer and narrowing profit margins.
However, what really matters over the long term are the growth in corporate profits. Stocks like Loblaw, Primo Water, Walmart, Monster Beverage, Stryker, Rogers B, T.Mobile, Altagas, Eli Lilly and Novo Nordisk continue to report improving profits.
Even companies like Premium Brands and Jamieson will see their corporate profits improve over the next several years.
When bottom fishing equity sectors with poor price momentum, it is critical to focus on company fundamentals. Simply purchasing a stock because it looks cheap or because it is at the bottom of its 52- week high-low price range, is a recipe for disaster. There remain many value traps in the market like BCE, Algonquin Power, CPX and Unilever. While investing in these value traps may appear tempting, I encourage all of you to focus on companies with strong fundamentals, rising dividends with low payouts and strong balance sheets.
Within these currently out of favour sectors are many solid companies with good growth prospects. Companies like Rogers B, Premium Brands, Altagas, Brookfield Infrastructure and Pfizer are some examples.
While I continue to like Walmart’s fundamentals, the forward PE at 25 times is on the expensive side in relation to its earnings growth prospects.
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