Value manager Gavin Ivory, vice-president and head of the global equity team at Toronto-based Beutel, Goodman & Co. Ltd., is calling for a revival in U.S. discretionary consumption, given that U.S. unemployment has peaked and is gradually declining.
"Investors in U.S. equities have underestimated the benefit to the U.S. consumer from the robust growth in the emerging economies," says Ivory. This growth is having a positive impact on the developed world as a whole, he says.
In the case of the United States, "large capital flows from China have been pouring into U.S. industries as capital investment, making U.S. industrial companies more competitive globally." U.S. industrial stocks have already risen sharply in recognition of this and are expensive, he says.
Taking the pulse of the U.S. consumer, Ivory says that the resurgence in the U.S. industrial complex has boosted employment. "U.S. manufacturing jobs increased last month for the first time in a decade."
Ivory notes that U.S. retail sales have been rising for six straight months to a new "record high." While the pace is likely to slow in 2011, it will still be an important source of economic vitality, he says.
U.S. consumers are, he says, still managing to repair their balance sheet by building savings and reducing debt burdens. On a cautionary note, he adds: "The prospect of rising U.S. interest rates is a concern."
Rising rates will certainly do little to help the moribund U.S. housing market, says Ivory. "We are not expecting a recovery in this market any time soon." A key indicator, U.S. single-family housing starts, reached a new low in December, he notes.
Ivory is cautious about the outlook for the U.S. equity market as a whole. The S&P 500 Index has gone up almost 90% from its March 2009 lows, he notes. In 2010, the index rose 13%, with a big spurt in the final quarter. "I expect the gains in 2011 to be more modest. Some sectors of the U.S. equity market are now fully valued."
Beutel Goodman manages assets of $22 billion for institutional investors, private clients and mutual funds. At the firm, Ivory and his global team, which includes Glenn Fortin, who is the lead manager on the U.S. equity portfolio, are responsible for assets of $1.2 billion. The global team's retail mandates that encompass U.S. stocks include Beutel Goodman American Equity and Beutel Goodman World Focus Equity.
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| Gavin Ivory | |
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The global institutional portfolio and Beutel Goodman World Focus Equity have roughly 50% of their weighting in U.S. stocks. This is in line with the weighting in the MSCI World Index, which focuses on developed countries.
The U.S. portfolios, including the Morningstar 5-star rated Beutel Goodman American Equity, have a substantial weighting in consumer stocks. At the end of last year, the portfolio, which has 28 names, had 17% in consumer staples and 12% in consumer discretionary stocks for a total of 29%.
In the U.S. consumer-discretionary sector, the team built up a holding in "well positioned, well managed department store chain," Kohl's Corp. KSS, in the second half of 2010.
Kohl's, says Ivory, is a family-focused, value-oriented chain that operates mainly in the southeast, mid-Atlantic, and western United States. He says it offers a range of merchandise including clothes, beauty and home products and small electronics in well designed stores. "Private/exclusive brands make up as much as half its total sales."
The company has an excellent inventory-management system, Ivory says. "It is gaining market share and there is room for it to expand." It has strong financials, with US$2.5 billion in net cash on its balance sheet. Kohl's has bought back 12% of its outstanding stock over the past five years, and "we are hopeful that it will start paying a dividend this year." The stock trades at 12 times earnings per share estimates for 2011, "which is cheap."
Also in the consumer-discretionary sector, the global team "significantly" added to its holding in the retailer Lowes Cos. Inc. LOW in the second half of 2010. Lowes, which has 17% of the U.S. market, specializes in smaller-ticket items, "which tend to be the first to recover." Home-improvement retailers have had a tough number of years, says Ivory.
"Lowes has rightly slowed down its store expansion dramatically and is focusing on increasing the profitability of its existing stores." Given its more modest capital expenditure and probable increase in sales, the company is expected to substantially increase its free cash flow and its dividends over the next few years, says Ivory. The stock trades at 15 times 2011 estimates. The current dividend yield is 1.8%.
| Kohl's Corp. | Lowes Cos. Inc. | ||
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| Jan. 25 close | $52.55 | $25.56 | |
| 52-week high/low | $44.07-$58.99 | $19.35-$28.54 | |
| Market cap | $15.4 billion | $35.3 billion | |
| Total % return 3Y* | 7.9 | 2.6 | |
| Total % return 5Y* | 3.0 | -3.2 | |
| Total % return 10Y* | -2.9 | 8.5 | |
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| All figures are in US$ *As of Jan. 25. 2011 Source: Morningstar |
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Turning to the U.S. technology sector, the global-equity team added to its holding in the communications-infrastructure giant Cisco Systems Inc. CSCO after the stock fell below US$20. This decline was due to concerns about "slowing sales to governments in developed economies, the company's market share and its product innovation."
Cisco's stock price, currently at 12 times 2011 earnings-per-share estimates "adequately discounts these issues," says Ivory. Cisco "will benefit from the revival in the U.S. business sector." The company has more than US$20 billion in net cash, he notes. The stock has a free cash flow yield of 10%. "We expect Cisco to start paying a dividend soon."
Also in the U.S. technology sector, the team trimmed its holding in Fiserv Inc. FISV and allocated the proceeds to Cisco. Fiserv provides back-office electronic transactions services to financial institutions. The stock, says Ivory, "reached our target price and, as per our discipline, we sold one third of our holding."
Another trim was of the major integrated energy company ConocoPhillips COP. The company "has improved its capital allocation" by selling or reducing its assets to concentrate on those with the highest return on capital. "This restructuring is mostly complete and the valuation reflects this." But, says Ivory, the stock is "still not expensive at 11 times EPS estimates for 2011."
