Monthly Update—North American Equity Mandate October, 2013
We did not add any new positions to the portfolio this month.
CGI Group: We sold CGI Group on reports that the company was using accounting techniques to show strong progress in its Logica acquisition. Our focus on capital protection makes us uncomfortable owning any company where accounting questions arise.
Cigna: When we bought Cigna, a U.S. health insurance provider, our thesis was that the overall uncertainty stemming from U.S. health care reform was creating a buying opportunity. The majority of Cigna’s client base is large corporations, which we expected to be slow to make drastic changes to their health insurance plans. As such, the impact to Cigna’s profitability would be minimal. Over the last several weeks, however, we’ve seen major corporations, including Walgreen, IBM and Time Warner, announce that they will start giving employees money to buy their own health coverage through the newly created exchanges. While Cigna is a well managed company and will likely adapt their business to meet client needs, these developments clearly contradict our original thesis, which is why we sold the stock.
Company Updates: A Few Highlights
WestJet: The stock was a strong performer this month on the back of better operating results. The stock was up 13.3% in September versus the TSX Composite and S&P 500, which were up 1.1% and 3.0%, respectively. North American airline fundamentals continue to look positive and we look forward to accelerating revenue growth from Encore, WestJet’s recently launched airline. We anticipate this will drive the share price higher over the next several quarters.
Brookfield Office Properties (“BPO”): We avoided investing in REITs this year as investor appetite for yield had driven valuations to very high levels, which created significant risk of capital loss. Our thesis was confirmed this summer when the U.S. Fed hinted that it would start easing asset purchases, which caused interest rates to spike. As a result, the share prices of yield sensitive stocks, including REITs, fell substantially. Year to date, the top 10 REITS in Canada are down 12.3%, on average. However, we saw BPO as an anomaly amongst REITs due to its upcoming lease renewal in lower Manhattan, which was causing the stock to trade at a discount to the underlying value of its properties. This month, Brookfield Property Partners, which owns 51% of BPO, announced an offer to purchase the remaining interest in BPO for $19.34/ share, a 15% premium to the stock’s trading price. This investment has played out very well for our investors with BPO up 17.2% in September and 16.4% year to date.
Timken: The company decided to go forward with an activist shareholder proposal to split the company in two, where its bearings & transmission business and its steel business will become two separate, publicly traded companies. Timken’s steel business is a high end, high margin producer, which should command higher valuation multiples. This will be a tax free spinoff for shareholders and the split is targeted for completion in 12 months. Timken was a strong performer, up 7% this month.
FedEx: FedEx reported quarterly earnings in September. While the results were in line with expectations, the company commented that it was ahead of schedule on its cost cutting program. This is important to our investment thesis as the initiative would increase operating earnings by $1.7 billion, +50% from current levels, without the need for an improving economy.
Home Capital Group: The stock was a very strong performer, up 12.5% in September. Short interest in its shares (the percentage of investors betting for the stock to fall) continues to decline with the company announcing intentions to purchase 10% of its public float. The valuation continues to look attractive at 10x earnings.
U.S. Government Default: Over this past year, our monthly notes have highlighted numerous events which were serious enough to derail investor confidence and cause a sell off in stocks. Our view has been to use these events as buying opportunities, and this has been the best course of action as markets, especially in the U.S., have continually traded higher.
The market’s focus has now turned to the U.S. Government and whether its political parties can reach a consensus in order to avoid a fiscal default. While this event also carries the potential to derail confidence, we continue to view it as a buying opportunity. Markets ultimately fall when valuations are so high that even good news cannot justify stocks going higher. Despite the market’s strong performance, we do not yet see valuations at high, risky levels.
In fact, while the market as a whole is more fairly valued than undervalued, and there are pockets that carry higher risk (such as yield-related stocks), we continue to find compelling opportunities in our universe of stocks. Active management, with concentrated portfolios and strong stock selection is key, however, and we continue to be selective in the stocks we buy on behalf of our investors.
As always, feel free to contact us at any time.