Martin Cobb, Senior VP, Equities, Lorne Steinberg Wealth Management
FOCUS: U.S. & Canadian equities
Top Picks: Saputo, Smith & Nephew, Electronic Arts
MARKET OUTLOOK:
Trump’s tariffs – will he or won’t he? If so, how big, starting when and for how long? The point is that nobody knows. That being said, the economic outlook is always uncertain. It’s just that investors and commentators occasionally forget that. The economy already faces some significant headwinds, and anything that damages confidence (or has the potential to) will act as a further drag.
The economy and the stock market however are more distinct from one another than most realize. Even if we knew with perfect foresight where the economy was heading, that would not necessarily help us in predicting what the stock market might do. The great fear that dominated 2022 was that interest rates would stay higher for longer. Well, it appears that is indeed what has happened, but it hasn’t stopped markets progressing.
Valuations today are fairly full, particularly south of the border. Some strip out the ‘Magnificent Seven’ so as to arrive at a cheaper valuation for the ‘S&P 493,’ but then you probably cut in half the overall growth rate in corporate profits. Internationally, valuations, on the surface at least, appear much more appealing but overall growth is much more subdued, so one has to be selective.
Rather than trying to predict the future, recognize that it is inherently unpredictable - think probabilistically and position oneself accordingly. While markets have the potential to climb higher, the current environment suggests a more tempered approach is warranted. A well-diversified portfolio, balancing growth opportunities with defensive positioning, remains prudent.
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TOP PICKS:
Saputo (SAP TSX)
Saputo is one of the world’s top 10 dairy processors, being the market leader here in Canada (as well as the U.K. and Australia) and number three in the United States. The U.S. is by far their biggest market, approaching half of sales, albeit less in profits, and with Canada accounting for about a quarter of sales (and a bit more in profits).
Roughly half of their business is retail, one third food service and one sixth industrial. It had a history of low organic sales growth, supplemented by continued acquisitions, and very stable operating margins earned thereon. It recently suffered from commodity price pressures and industry oversupply, resulting in very low (even negative at times) bulk milk-cheese spreads, particularly in its key U.S. food service operations. Perhaps the stability of yesteryears was more the exception than the norm and that this is a lower quality enterprise than many once thought.
Even so, if operating margins only get back to, say, the 7½ per cent low point of the 15 years prior to the pandemic, that results in around $2.30 of earnings per share. That would see the stock trade on a mere 10-11x earning versus a long-term average of closer to double that.
Smith & Nephew (SNN NYSE – ADR version)
Founded in 1856, Smith & Nephew today is a leading provider of medical products such as hip and knee implants, soft tissue repair systems, sports medicine and advanced wound care treatments. It competes with the likes of Stryker and Zimmer Biomet as well the DePuy division within Johnson & Johnson and holds a top four market position in each of its areas of operation.
Folks around the world are both living longer and getting heavier, leading to increased healthcare demand generally but even more so in the area of hip and knee replacements, advanced wound care, sports injuries etc... Moreover, pandemic induced reduced demand for elective surgeries is still playing catch-up. Underlying market growth is expected to be of the order of four per cent annually and one would anticipate they can at least hold their own therein, if not more so.
With a bit of room for margin recovery, they should compound earnings per share at close to the 10 per cent level. Today it’s trading on 13x 2025 earnings versus an historic multiple more like 19x and Stryker on 29x.
Electronic Arts (EA NASD)
Arguably the most ‘utility-like’ of the videogaming companies, EA has a broad portfolio consisting more of dependable franchises than one-off hit titles. Key sports titles include EA Sports FC soccer, Madden NFL, NHL, and Formula 1. EA also has Sims, Apex Legends as well as games based on movies such as Harry Potter and Star Wars.
It’s a market leader but with only a few % points share of a highly fragmented market, with 80 per cent gross margins translating into 30 per cent-ish at the operating and free cash flow level. EA is witnessing some pressures on the top line presently but should still be able to grow sales over time in the mid single-digits and earnings per share at perhaps double that. It simply chucks off cash and has enough, after capex and dividends, to buy back more than five per cent of its share count each year at today’s share price levels.
It generates roughly the same revenues as that of Activision Blizzard did and that was taken out at over a 100 per cent premium to today’s EA valuation.
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| SAP TSX | N | N | Y |
| SNN NYSE | N | N | Y |
| EA NASD | N | N | Y |
