Also available in PDF: MIR Portfollios February 2021
Investment Commentary February 2021
US Yield Curve
The ten minus two- year US Treasury yield curve has jumped to 1.10% as of February 5, 2021 from 0.68% in November. This is positive for the economy. In particular the ten- year US treasury yield has risen to 1.19 %.
US Corporate Debt Spreads
As of February 4th, Aaa rated US corporate bond spreads relative to 10 year US Treasuries backed up to 1.46%, from the December 28th level of 1.31%. The Baa rated US corporate bond yield spreads are approximately what they were at year end while High Yield spreads continue to remain at low levels at 300 basis points. Once again this is positive for the US economy and indicates that the probability of the US dipping into another recession at this point is low.
US / China Trade Issues
Joe Biden and the Democrats are expected to be more conciliatory with China, although it is too early to tell at this point.
Covid – 19 Health Stats
The number of new cases in the US is starting to see a decline from the high levels over the last several months. In addition, the number of people being vaccinated is considerably higher than the number of new daily cases. As a result of no current drug vaccine manufacturing being available domestically, Canada’s percentage of people being vaccinated remains very low. But this is about to change over the next few months with several agreements with the major drug companies including Pfizer and Moderna promising a material increase in vaccine shipments.
Equity Market Valuations
Historically both the S&P 500 Forward and Trailing PE multiples are at high levels. However, when you take the current low level of interest rates, equity market valuations seem more reasonable.
US Domestic Economic Growth
The US economy is slowing down as evidenced by the recent weak payroll employment number. However, the improving trend on the vaccine front combined with more fiscal stimulus on the way bode well for the economy in the second half of this year.
Central Bank Monetary Policy
Global central bank policies continue to be very accommodating. Some investment pundits are concerned about the possibility of much higher interest rates this year and next to combat an increase in the rate of inflation. However, Jerome Powell, the Chairman of the Federal Reserve has stated on several occasions that the central bank is prepared for somewhat higher inflation before they are likely to even consider raising rates materially.
I am maintaining the same asset mix as last month for both portfolios.
Equity Sector Weights
I am not making any change from last month in relation to the benchmark weights. I remain overweight Financials, Energy, Materials, Industrials, Consumer Discretionary, Utilities and Real Estate. I remain underweight Communications, and Consumer Staples. Lastly, I remain market weight both Technology and Healthcare.
Individual Equity Changes
In a portfolio blog dated January 21st, I added Cascades to both portfolios in the Materials sector. The company is a major producer of containerboard and packaging products in Canada, the US and Europe. The company is a strong generator of free cash flow and offers a dividend yield of 1.99% that is well covered by cash flow.
In a portfolio blog dated January 15th, I removed Northland Power from both portfolios as a result of its high valuation and mediocre growth prospects over the next few years relative to its peers. However, I still like the company and would consider adding it back to the portfolios should its expected earnings growth rate start to accelerate once again.
In a portfolio blog dated January 19th, I deleted Alimentation Couche-Tard from both portfolios. The company has a history of making accretive acquisitions, but is having difficulty finding acquisition candidates that will be as beneficial to their bottom line. Consequently, its growth prospects are decreasing. Its latest failed takeover of a French grocery store company with some convenience stores was fortunately rejected by the French government. Furthermore, the grocery business is totally different than its core convenience store business and has much lower operating margins.
I am adding two new companies to both portfolios in the Materials sector- namely Nurtien and Linde PLC.
Linde, an Irish company merged with the US company, Praxair several years ago. The combined company is the largest industrial gas supplier globally where it competes directly against Air Products. The industry is dominated by only 4-5 companies. Its recent 4th quarter sales climbed 30% year over year while its operating profit and adjusted earnings per share rising by 20% and 22% respectively. Its operating cash flow also rose by 12% over the same period. For the full year operating profit and adjusted earnings per share rose by 10% and 12% respectively. Operating cash flow for the full year rose by 21%. The company expects adjusted earnings per share to grow by 11-13% this year. Differing from Air Products, Linde has consistently beaten their quarterly earnings per share consensus estimates for the last eight quarters. Air Products record was more volatile and inconsistent in this regard. At current prices after its recent price runup last Friday, both companies trade at approximately the same valuation on 2021 earnings per share. Both companies have comparable growth prospects in earnings per share. Linde offers a dividend yield of 1.65% that is well covered by cash flow. The overall industrial gas industry is expected to show solid growth this year and next with both companies benefitting from this recovery.
I am also adding the Canadian fertilizer company, Nutrien to both portfolios. The company is the largest potash producer globally and also produces nitrogen and phosphate. As a result of its size and access to low -cost natural gas feedstock, the company has one of the lowest costs in the industry in regards to both potash and nitrogen. On the other hand, it is a relatively higher cost producer of phosphate -based fertilizer. Nutrien offers investors an opportunity to participate in rising fertilizer demand from higher global crop prices. The company also has a very large retail distribution channel where it sells all types of fertilizer products directly to farmers at over 2,000 retail locations throughout North and South America and Australia. The company has a strong balance sheet with a debt/equity ratio of 0.53. Revenues, cash flow and earnings per share are expected to see solid growth in 2021. While the company’s share price is not cheap, its industry leading cost advantage in potash and its growing retail distribution network make the company an attractive purchase. The company pays a dividend of 3.34% that is well covered by cash flow.
Peter McMurtry, B.Com, CFA
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