Guest: Mark DeVaul, Co-portfolio manager of the Hennessy Equity and Income Fund (AUM: $6B)
Topic: Market Monitor
We believe these names are trading at a discount to the broader market. The market isn’t cheap today, but you can still find great investment opportunities.
Thoughts on the Market
We recognize the market isn’t cheap after nine years of a market rally and economic recovery. While stocks are not cheap overall, we are still finding high conviction ideas. We only need a handful of new ideas each year to populate our roughly 30 stock portfolio with 20% annual turnover.
Our view of the market is mixed reflecting a strong economy combined with a relatively high valuation and monetary tightening from the Federal Reserve. The US consumer is in good shape with low unemployment, rising wages, and the benefit of tax cuts enacted early in the year.
We think the current valuation of the market can be sustained if inflation and interest rates remain low. However, we believe the Fed will continue to raise the fed funds rate while slowly reversing quantitative easing. In addition, the strong labor market could lead to an increase in wage inflation. The impact of higher rates doesn’t necessarily mean lower stock prices, but it will likely lead to a reduction in valuation multiples. In that environment, we expect greater volatility and more muted equity market returns (vs. the 10%+ gains over the last few years).
Dollar Tree (DLTR)
· Dollar Tree operates close to 15,000 stores across the US and Canada and has generated over $20B in sales through these 15, 000 stores.
· The company acquired Family Dollar in 2015, which is focused on more urban markets and a broader range of price points.
· There is a fair amount of negativity around Family Dollar priced into the stock today. After three years under Dollar Tree management, Family Dollar stores have continued to struggle, negatively impacting DLTR stock.
· But over the next 1 to 3 years we think this changes and you see big upside at Family Dollar as Dollar Tree focuses on improving operations at that division
· Stock trades at about $80 a share now. We see it getting in the $110 to $120 range over the next 1 to 3 years
Carnival Corp. (CCL)
· Well positioned as the global leader in a tax advantaged, consolidated industry with high barriers to entry. In its primary markets, niche providers (luxury cruises, adventure cruises, etc.) provide the only real threat of new entry. The capital requirements of building a cruise ship are massive ($500 million to over $1 billion per ship – CCL owns roughly 100 ships) and the lead times for ship delivery are long (3 years). Carnival’s scale allows it to price out competitors in the mass market while still earning mid-teens margins.
· It also has strong demographic tailwind – aging population, which helps the demand for cruising. In CCL’s core developed markets, older customers tend to cruise more frequently while millennials focus their spending on experiences.
· Recent weakness in the shares, reflects rising fuel costs and temporary disruptions in the Caribbean, leads to an attractive time to buy the stock, which is at about a 20% to 30% discount to the overall market
· In the next 1 to 3 years, stock could hit the $80 to $85 range
· We really like Apple’s ecosystem. This ecosystem has high switching costs that make current users more reluctant to stray outside the ecosystem for future purchases.
· Apple has a sterling brand, strong product pipeline, and ample opportunity to gain share in many end markets. And remains highly competitive
· We believe Apple has barely scratched the surface with penetrating corporate customers, allowing this to happen organically via user recommendations.
· We believe the downside is well protected by its incredibly strong balance sheet. The company has over $120B in net cash and investments.
· Management has been open about returning cash to shareholders and recently announced a $100B expansion in its share buyback plan while increasing its dividend by 16%. Cash will continue to build as the company generates over $65B in annual operating cash flow.
We own all these names in client portfolios Hennessy