One of the crucial factors in choosing investments is a company’s ability to profitably allocate capital, says Garey Aitken, chief investment officer at Calgary-based Franklin Bissett Investment Management and lead manager of four-star Franklin Bissett Canadian Equity Fund.
The Franklin Bissett approach is long-term, with holding periods for companies typically running from five to 10 years. That’s why it’s important that companies generate a healthy level of free cash flow, and then intelligently invest that capital into expanding their businesses and increasing share value. Allocation choices could include enhancing existing products and equipment, mergers and acquisitions, share buybacks and dividend payments.
Dividends within reason
When it comes to dividends, rather than a juicy yield, Aitken looks for a “well thought out dividend program” where dividends are sustainable rather than uncomfortably high or “capricious.”
“Our preference is for companies that reinvest cash back into the business to the extent they can earn a healthy return,” Aitken says. “We are not fixated on yield. Yield is part of the total return, but at the end of the day it’s about growth and capital appreciation.”
Once he has found high-quality companies with a competitive advantage, balance sheet strength and growing earnings and cash flow, Aitken is willing to be patient for their long-term potential to be realized. He believes in “time arbitrage.”
Time will heal and realize the deal
“We look to achieve a persistent advantage over our benchmark, and strong corporate competitors in the Canadian marketplace are not easy to find,” he says. “Investing is a deliberate process and we play the long game. We look to buy at an advantageous price and take advantage of market inefficiencies in the belief that any disconnect between a company’s trading price and it’s underlying value will disappear over time.”
Positions will be trimmed if valuations become excessively high, however.
The portfolio shows strong long-term performance, with a 15-year average annual compound return of 7.66% as of Oct. 31 for Franklin Bissett Canadian Equity Fund F, a 1.62 percentage point advantage relative to its benchmark, the S&P TSX Composite Index.
Rates and trade take centre stage
Although committed to a bottom-up approach, Aitken says the most relevant big-picture themes that he is watching are the direction of interest rates and trade frictions between the U.S. and China, which could ultimately impact global growth.
“The ongoing battle between China and the U.S. has cast a pall over financial markets,” Aitken says. “Currently, we expect positive but slowing global growth. If trade tensions escalate, we could see a recession in some of the more vulnerable geographic regions.”
He says the direction of interest rates is largely tied to economic growth, and in 2019 central banks around the world have been in easing mode. However, he says the future direction of interest rates can change and is difficult to predict.
Given the low level of interest rates recently, the market has favored interest-rate sensitive and defensive stocks such as utilities, real estate investment trusts. While stock prices in these sectors have risen there are still opportunities, he says. For example, Allied Properties REIT (AP.UN). was added to the fund around mid-year.
Franklin Bissett Canadian Equity’s top sector weighting is financials at about 37% of the portfolio – slightly overweight relative to the benchmark. This sector includes the fund’s top holding, alternative asset management company Brookfield Asset Management Inc. (BAM.A), at almost 8% of fund assets. The big Canadian banks are also dominant holdings.
“Brookfield is a well-run business and its execution has been terrific,” Aitken says. “The company focuses on real assets such as infrastructure, renewable energy, and real estate, and has also generated healthy returns managing third-party capital,” he says. “Even though the stock has appreciated, the valuation remains attractive.”
Canadian banks have enjoyed steady growth and the valuations remain attractive, with any risks appropriately reflected in stock prices, he says. Royal Bank of Canada (RY) and Toronto Dominion Bank (TD) are the largest weights among the banks. The fund also holds investment management firm Onex Corp. (ONEX), and insurance companies Manulife Financial Corp. (MFC) and Sun Life Financial Inc. (SLF) in the financial sector.
The fund has almost 13% in consumer staples, its most overweight position relative to the TSX Composite, Aitken says. A new position, which was reintroduced to the fund this year, is food retailer Loblaw Cos. Ltd. (L). The company has been a solid performer and is well-positioned geographically, Aitken says. Its acquisition of Shoppers Drug Mart has gone well, he says.
Other long-standing favourites in consumer staples include Alimentation Couche-Tard Inc. (ATD.B), an operator of convenience stores and gas stations, and grocery store chain Metro Inc. (MRU) and dairy company Saputo Inc. (SAP).
A recent sale from the portfolio is Restaurant Brands International Inc. (QSR), parent company of Tim Hortons, Burger King, and Popeyes Louisiana Kitchen. After performing well for several years, Aitken says the company is finding same-store sales at Tim Hortons harder to attain. With the Canadian market becoming more saturated, profitable new locations are more difficult to find and expanding outside Canada has been challenging, he says. There have also been some clashes between management and franchisees.
Another recent sale from the fund has been Stantec Inc. (STN), an Edmonton-based engineering firm. The company has a long history of success but growth by acquisition is becoming more difficult as it gets bigger and integration of new businesses becomes more complex, Aitken says.
The energy sector has been under pressure and is underweight in the fund, but low valuations have presented some attractive opportunities and the fund holds a few names with attractive assets and cost structures, Aitken says. Holdings include Canadian Natural Resources Ltd. (CNQ), Enbridge Inc. (ENB), Keyera Corp. (KEY) and TC Energy Corp. (TRP).
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