Brian Madden, chief investment officer, First Avenue Investment Counsel

FOCUS: North American equities

MARKET OUTLOOK:

A recession is in the making and investors need to position portfolios defensively by overweighting cash, gold, consumer staples, utilities and other recession resilient or recession beneficiary businesses, whilst avoiding or fading many if not most of the leaders of the last cycle. Including the FAANG mega-cap growth stocks, consumer discretionary businesses, work-from-home beneficiaries, etc.

At the same time the diligent investor, recognizing that recessionary bear markets tend to last just 16 months on average, does his homework in advance and prepares his more aggressive shopping list for the new bull market that invariably follows a recession, just like night follows day. We are doing exactly that. Meanwhile, we are taking a selective, strictly best-in-class approach within the technology, industrial and financial sectors. Across the board, we are favouring self-funding companies with very strong balance sheets, in light of the rapidly rising cost of capital in the equity and debt capital markets.

Energy is a special case cyclical group where we continue to hold a healthy position predicated upon the attractive relative valuations within the group and the complex global supply challenges facing this, until recently, long-overlooked neglected and even outright despised corner of the market.  

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TOP PICKS:

Waste Management (WM NYSE)

Latest purchase June, 2022 AT $151.90

Waste Management is the largest and best-in-class competitor in the U.S. solid waste industry, operating collection, transfer, landfill and recycling businesses in 49 U.S. states and also operates in Canada. Ownership of 260 landfill sites is a competitive advantage for the company relative to peers and is the company’s financial strength, along with an “A-“credit rating in this fragmented and consolidating industry. The company’s prolific free cash flows have funded a dividend that grows at a 6 per cent annual pace and a steady share buyback program that retires 2-3 per cent of outstanding shares most years. Waste Management has grown earnings at an 8 per cent compound rate over the last decade and yields nearly 2 per cent, affording good visibility to a high single-digit return that is largely insulated from economic cycles, given the non-discretionary nature of the business.

 Dollar General (DG NYSE)

Latest purchase May, 2022 at $221.55

Dollar General is the largest dollar store in the U.S., with approximately 18,000 stores in 47 states and with a market capitalization of roughly $50 billion. Unlike Canadian dollar stores, this company sells mostly consumables (i.e. 75 per cent), and thus can be thought of as a hybrid retailer straddling the boundaries of a deep discount grocer and general merchant.

The growth algorithm is rooted in mid-single-digit same-store sales growth, bolstered by approximately 1,000 new store openings each year, and a generous share buyback program to take overall earnings per share growth up into the 12-14 per cent target zone. With a clientele that skews more low-income and rural than the national average, in the current environment where food/energy/gasoline and mortgage refinancing pressures are biting even middle-class households hard, we expect trade-down effects from other retailers to benefit Dollar General. Making this a somewhat countercyclical investment. This is not well understood by the market which threw this baby out with the retail sector bathwater last month, taking the shares down 30 per cent off a recent peak, affording us an excellent entry point.

Transalta (TA TSX)

Latest purchase May 2022 at $14.49

Transalta is a merchant power generator with 71 wind, solar, natural gas and hydroelectric facilities situated in Alberta (68 per cent), the U.S. (27 per cent) and Australia (5 per cent). Many of these assets are held indirectly through a controlled affiliate, Transalta Renewables.The business is pivoting away from legacy “dirty” fuels, most notably coal and towards renewables. With resultant re-rating implications over time, renewable power companies trade at nearly double the multiple of traditional power generators. Investor sentiment has been steadily improving since 2017 alongside price which is approaching ten-year highs. 

Utilities are a defensive sector in an upcoming slower growth environment. However, given Transalta’s heavy Alberta exposure, this company is a “backdoor” play on oil and gas which we expect to buck the softening trend of other industrial commodities, given the unique global geopolitical supply challenges.