McMurtry Investment Report Portfolios June 2024
Also available in PDF: McMurtry Investment Report – June 2024
Investment Commentary June 2024
US Yield Curve
The 10-2-year US Treasury yield curve closed at -0.44 as of September 7th, an additional inversion of 8 basis points from last month’s -0.36.
US Corporate Debt Spreads
As of June 7th, Moody’s triple B yield relative to the 10-year Treasury remained tight at 1.50% compared to last month’s 1.48%.
China
The Chinese Caixin Manufacturing PMI Index rose to 51.7 in May, representing the seventh straight month of expansion in factory activity and the fastest pace since June 2022. In addition, Chinese exports jumped by 7.6% year over year in May, beating consensus estimates of a 6% growth. These are positive economic developments for the world’s second largest economy and increase the probability of a global soft landing.
Equity Market Valuations
The forward PE of the S&P 500 remains at a relatively high level of 20.60 times.
US Corporate Earnings
The growth in S&P 500 EPS continues to climb. At the end of the 1st quarter of this year, 79% of companies reported positive earnings surprises vs consensus estimates. This compares to a 5 -year average of 77%.
The year over year growth in EPS was 9.6% for the 1st quarter and is expected to grow by 9.2%, 8.2% and 17.4% for the second, third and fourth quarters respectively.
These trends combined with a higher probability of a soft landing bode well for equity markets.
Central Bank Monetary Policy
For most of the last month the rhetoric from the Federal Reserve was much less hawkish. However, this past Friday’s monthly employment grew faster than expected with wage growth above consensus.
This will encourage the Federal Reserve to take more time before they start decreasing rates. This caused both the bond and equity markets to be quite volatile on Friday.
Asset Mix
While I still remain bullish on equity markets, there are many things to still worry about. Namely, the timing and magnitude of the Federal Reserve’s rate cuts are still up for discussion.
However, on a positive front, earnings growth is accelerating in the US and the probability of a soft landing is increasing. Lastly, the Chinese economy, especially the manufacturing sector, appears to be in an uptrend and this should be viewed positively.
Taking all this into account, I am leaving the asset mix for both model portfolios the same as last month in regards to both equity and fixed income exposure.
The only major change I am making this month is to eliminate the investment grade corporate bond exposure by replacing it with domestic Provincial Bonds. The corporate bond spreads of investment grade bonds vs. Government bonds narrowed sharply in both countries. The spreads are the lowest in many years and this has encouraged me to make this switch at this time. Corporate spreads may remain narrow for some time, but the very small additional return cannot justify the higher risk.
I am recommending the addition of two BMO ETFs, the ZPS Short Provincial ETF and the mid term Provincial ETF, ZMP. Both offer yield to maturities a little below 4.5% and are of the highest quality. More specifically, the mid Provincial ZMP ETF has an average yield to maturity of 4.37% with an effective duration of 6.243 years. The short Provincial ZPS ETF has an average yield to maturity of 4.45% with an effective duration of 2.50 years. Holdings only include Provincial domestic bonds.
For those of you selling individual investment grade corporate bonds, be careful placing your order as small bond holdings are not very illiquid. Use limit price orders if you are able.
Asset Mix- ETF Portfolios
Similar to the individual company asset mix, I am leaving the percentage weights for both fixed income and equity at the same levels as last month. However, I am making the same changes in the Fixed Income Area. On the Equity side, I am adding a 2% weight for both portfolios for each of the US Sprott Copper Miners ETF, COPP-US, and the Wisdom Tree’s Artificial Intelligence ETF, WTAI-US. In turn I am reducing the US percentage weight for the BMO S&P 500 Index ETF, ZSP by 4%.
Equity Sector Recommendations
Similar to last month, I am not making any changes to my equity sector weights compared to my North American benchmark weights.
However, as summarized in this month’s Investment Newsletter, I am increasing my overweight for Reits for both portfolios to 3.25%.
I would like to point out exactly what is going on with the energy sector. Crude prices have dropped sharply over the last month. Crude prices have erased their geopolitical risk premium that was evident in the price after its recent fall.
Secondly, there was an OPEC meeting this past week that resulted in a phase out of some of OPEC’s production cuts by the fall by several million barrels per day. Commodity markets did not like this announcement leading to a sharp fall in the crude price. However, the next day Saudi Arabia indicated that this new production phase out agreement was not binding and could be easily reversed by the Saudis alone should crude prices fall more from here. This stabilized the commodity price on Friday. RBC’s Commodity Strategist, Helima Croft, also highlighted the fact that the Saudis could change their mind very quickly. The Saudis do not need the other OPEC members agreeing to a production cut as they could unilaterally initiate another production cut of the same number of barrels per day if the price if oil falls materially from the current levels.
Individual Stock Changes
In a portfolio blog dated May 16th, I added the US data center Reit, Digital Realty to both portfolios in the Reit sector. The growth in data centers is all coming from the massive increase in Artificial Intelligence where the data centers house all these high- end computers with the advanced Nvidia’s semiconductor chip.
In a blog dated, May 21st, I deleted Silvercrest from the Growth Portfolio in the Materials sector. The company’s mine is located in an area where there is an acute shortage of water and this is making it difficult for the company operationally.
In a blog dated May 23rd, I deleted Ludin Mining, Capstone Mining, Ivanhoe Mines and HudBay. As a result of their very strong investment performance recently, I felt that some profit taking was needed for these highly volatile, cyclical stocks.
In a blog dated May 24th, I added the much less volatile, Freeport McMoran to both portfolios in the Materials sector.
In a blog dated May 28th, I added Sprott Copper Miners ETF, COPP-US to both portfolios in the Materials sector. This is a more conservative way to paly the global copper producers.
In a blog dated June 7th, I added back Capstone Mining to the Growth Portfolio in the Materials sector. The share price had fallen by 19% from its recent high and is still expected to increase its copper production by 25% this year.
I have decided to delete Open Text from both portfolios in the Technology sector. While the stock is trading at very cheap valuations, the company continues to underperform its peers. There is an opportunity cost continuing to hold companies like this when there are many other companies in the same field with better prospects.
Lastly, I am adding the US school bus manufacturer, Blue Bird Corporation, BLBD-US, to the Growth portfolio in the Industrials sector.
Differing from NFI Group that mainly focuses on the production of mass transit buses, Blue Bird is exclusively producing school buses with low to zero emissions. While they still build gas and diesel- powered school buses, their focus is principally on EV buses. Blue Bird is an industry leader in low and zero emission school buses. Currently 60% of their sales are non diesel school buses, compared to only 10-20% for their peers.
Their main competitors are Thomas, IC and Lion. IC is owned by Navistar who in turn are owned by Traton Group. The school bus division is only a small part of Traton’s operations.
Thomas is owned by Daimler and once again the school bus division is only a small part of their operations.
Lastly, Lion is their smallest competitor that is a public company. It is having great difficulty in its profitability against its larger rivals like Blue Bird.
School Buses represent the largest part of the US mass transit market. The industry has 500,000 school buses in operation in the US and Canada transporting 26 million children. The population of school bus children is growing.
As these school buses are principally bought by municipal governments, the funding of these buses is derived mainly by property taxes in the US.
The average age of the current school bus fleet industrywide is 10 years plus. The demand for new school buses is driven by the number of school age children, the age of the fleet and the average ridership per bus.
Blue Bird differentiates itself from its peers in the fact that it is an industry leader in alternative power school buses.
The recently passed US Infrastructure Bill has directed $5 billion of US Funding for EV school buses. Currently there are rebates and grants available to the municipalities to replace their existing school bus fleet with new, zero emission, EV buses. Blue Bird expects to obtain 30% of these new future orders.
Non- GAAP consensus EPS are expected to rise by 153% in 2024 and by over 15% in 2025.
Revenues and EBITDA are also expected to grow year over year in 2024 by 16.7% and 82% respectively.
Over the last five quarters, both operating cash flow and EBITDA have registered solid growth both on a trailing twelve month and on a quarterly basis.
The company’s most recent quarter saw Revenues and Gross Profit jump by 26.19% and 270% respectively. EBITDA rose from a loss of minus $4.15 million in the 1st quarter of 2023 to a profit of $129.44 million for the 1st quarter of this year.
Currently the stock is trading on a forward PE basis of 20.83, much higher than its 5 -year average of 16.57 times. However, when one takes into consideration the high projected growth rates in EPS, Revenues and EBITDA this year, paying this multiple does not seem excessive.
Using the Enterprise Valuation to the Forward EBITA shows a multiple of 11.43 times, actually lower than its 5- year average of 33.78 times.
The company’s financial condition is also solid with financial debt only representing 0.984 of Trailing twelve- month EBITDA. This is much lower than its 5- year average of 4.3 times.
The company does not pay a dividend.
The stocks technical chart pattern shows a rising trend with a recent RSI of over 71. This implies that the stock may be overbought on a short -term basis. Its share price is above both its 50 and 200 -day moving averages of 42.54 and 28.92 respectively at the current price of 56.35.
Despite the share price’s current overvaluation, I still very much like the company’s prospects for growth in their Revenues, EBITDA and EPS. I recommend a half position of 1-1.50% of your total equity holdings given the shares’ recent outperformance.
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