If I told you at the end of 2019 that the coronavirus affecting China at that time would spread to the entire world and that it would be blamed for nearly 2 million deaths, including over 300,000 in America, you would not have believed me.
If I then told you that governments worldwide would ban everything from air travel, to shopping, to restaurants, to beaches, to doubles tennis to children’s playgrounds, again you would not have believed me.
Of course, neither I nor anyone else told you these things a year ago, or even nine months ago. There are no experts on the future: no one has been there yet.
However, if you want one factor to look for in 2021, the determining factor is interest rates. As long as interest rates stay low, money will look for a home in assets, whether it is in real estate, French wine, Group of Seven paintings, or in the stock market. The prices of these assets will rise. Once investors get the idea that rates will go up, then the stock market and many other asset classes will be vulnerable.
Having said that, a year from now we could be marveling at negative interest rates in North America during the greatest economic boom in modern times with the Dow over 40,000. In that case, the French wine will be on me.
May everyone have a safe, blessed and happy new year!
Home Depot (HD NYSE)
A strong housing market supports home improvement demand in the near to medium term:
- The median age of the U.S. housing stock is 40 years in 2020.
- U.S. homeowner equity has risen every year since 2011, growing at a 15 per cent compound annual growth rate until 2019.
- The 30-year fixed rate on U.S. mortgage rates remains below 3 per cent, which supports housing activity as well as refinance activity to fund large home improvement projects.
Home Depot has proven itself a superior operator and an above-market grower through cycles:
- Growth has essentially been entirely organic; sales per square foot went from $300 in 2010 to $450 in 2019 while total store counts were roughly flat.
- Operating margins went from 8 to 15 per cent over the same time period.
Management continues to make investments that will serve both DIY and professional customers better in-store and online. These have weighed on margins over the last two to three years, but expansion should continue after the “heavy lifting” period of investments.
Entrance into new categories within home décor expands the total addressable market and help capture market share from (struggling) competitors. Home Depot has performed very well this year, but we think there is still room to run.
Alimentation Couche-Tard (ATD/B TSX)
A consolidator in the convenience store/gas station industry, Couche-Tard is leveraging its scale to reduce costs and improve margins of acquired chains. Recent entrance into the Asian market increases the company’s total addressable market, helps drive topline growth and is margin-accretive to the overall business.
Renovated, attractive front store locations help drive increased, high-margin attach rates for fuel purchases. Even with 12,500 locations across North America and Europe, it and 7-Eleven only hold approximately 15 per cent of the market. We believe the company’s proven execution capabilities will allow it to continue taking market share for many years to come, aided by strong free cash flow generation and an under-levered balance sheet.
Intercontinental Exchange (ICE NYSE)
Intercontinental is a global financial exchange operator and financial data provider. Its exchange business benefits from increased volatility through higher trading fees, enjoys high barriers to entry and has taken share from other operators in the commodity space over a number of years. The data business provides a high-renewal, high-margin recurring revenue stream that is separate from exchange transaction fees.
More recently, it completed its digital end-to-end solution for the U.S. mortgage industry by acquiring Ellie Mae:
- Ellie Mae expands its mortgage-related total addressable market by about $10 billion over the long term.
- Forty per cent of the business operates under a recurring revenue model with renewal rates in the high 90s.
- A small but growing fixed income business should benefit from the proliferation of fixed income index ETFs and the related increase in electronic trading that comes as a result.
- In 2019, less than 50 per cent of cash investment grade and high-yield fixed income trading occurred through electronic means, up from the mid-teens in 2012 but well below the 90 per cent level for cash equities.
In summary, wide moats, high margins, strong free cash flow and an expanding addressable market make this an attractive long-term hold.