Integer Investments: Our portfolio and views for 2017
We have just archived a turbulent but successful 2016. Our portfolio performed very well (26% ROC, 44.9% ROI) and we believe that we are well positioned for another great year. Yet, we enter 2017 with lots of skepticism. Risks abound and we take them seriously. Below are just a few examples of what could drive markets lower:
Brexit: Although we have been reading about Brexit for long time, many investors have put this to the back of their mind. Yet, most problems are in front of us. The U.K. should trigger Article 50 (and formally commence its exit from the EU) within a few months (March/April). Then a long negotiation period full of uncertainties will begin. Triggering Article 50 and the negotiation process itself are dangerous events for the markets.
Trump: We don’t like the newly elected President. And very few investors liked him until he was elected. In fact, markets started the day he won the presidential election by losing 5%. And then? Well, markets started loving him and now we talk about the “Trump rally”. Trump is unpredictable and misleading. He might implement no policies, good or bad policies. He is the first one to be confused about his strategy. So, nobody knows what he will really do. The problem is that now markets expect him to implement perfect policies that will make America great again. Therefore, as soon as we realize that perfection won’t be delivered, markets might quickly adjust.
Rates: The FED has started to raise rates. It will probably continue to do so in the coming quarters. Now inflation is picking up in Europe and the U.K. and soon the central banks will face some policy dilemmas. We think that higher rates will finally balance the economy and reduce distortions, but this will have broad consequences on asset prices (including stocks).
Eurozone: Various countries are facing political risks due to elections. There is a constant anti-euro feeling. Brexit might trigger new propaganda against the Euro. There is a chance that not much will happen, but still this is a risk.
China: We believe that China has a resilient economy and a very hard working and ambitious population. Hence, they will be able to weather prospective financial risks that lay ahead. However, it is well known that China has a real estate and debt problem that might explode. We also don’t believe that Trump will actually implement any tariffs against China but this is an additional risk for the country and the global economy.
These are just some risks that could materialize in 2017. We don’t think that any of them will arise in their full form. However, markets are expensive, so any minor adjustment in investors’ perception would be detrimental to performance. A couple of simple metrics show how expensive these markets are: Market capitalization to GDP and Shiller P/E ratio.
The first graph shows the relationship between market capitalization and national GDP. The ratio is expected to be around 100%, when it goes above we face a risk of market correction. This happened in 2001 (tech bubble) and 2009 (financial crisis). Now the market capitalization is 127% of national GDP. This means that markets are significantly overvalued (source: GuruFocus).
The second indicator is the P/E Shiller ratio. This indicator measures the relationship between the price of stocks and the value of earnings. The Shiller P/E ratio is based on average inflation-adjusted earnings from the previous 10 years. The graph below shows that current levels are in line with the 2009 crisis and just below the Black Tuesday correction (source: www.multpl.com).
In sum, despite the market enthusiasm, we start 2017 with a note of caution. We believe that our investment approach can provide good returns even if the market corrects itself and we will be ready to take advantage of any eventual corrections.
We think that developed economies are the best way to guarantee long-term risk-adjusted returns. We explore markets such as the U.S., Canada, the U.K., Germany, Switzerland and Italy, looking for investment opportunities. At present, 55% of our portfolio is in U.S. stocks, 8% in U.K. stocks and 3% in German stocks (the rest is in cash). We are long with 66% of our portfolio, we have a short position equaling 3% of our holdings, and cash represents 37%.
We recently changed our portfolio allocation to add a few pharma stocks. We believe that the sell-off in this industry is exaggerated and that several stocks offer compelling opportunities. The pharmaceutical industry is also a defensive sector in case of a downturn.
(The sum of the sectors is above 100% due to the short position)
Below are our holdings in order of value, from largest to smallest. All acquisition prices include commissions.
Cash: In line with the above reasoning, we hold a large cash position. This will provide a good buffer against market corrections and allow us to buy stocks at cheaper valuations.
Deere (DE): Deere is a solid company with a great management. Recently, it has faced some problems due to lower commodity prices and weak agricultural markets. We started a position in Q3 2016 at an average price of 80.08. Now it is priced at $105.38, providing a gain of 32% plus dividends. The company is not a bargain anymore but we like it as a long-term quality play.
Nike (NKE): We started a position in Nike at the beginning of 2017. We think that Nike is a great company that will thrive in the long-term. The stock was very weak in 2016, losing approximately 20% of its value. The main argument is that competition from the likes of Under Armour (UAA) will have a negative impact on Nike’s growth. We are excited that we could buy shares at a reasonable valuation. We bought the shares at an average price of $51.86 and within three days we have a potential gain of 2.2%.
International Business Machines (IBM): We have written many public articles about IBM. IBM is an historical company facing some turnaround problems. Yet, it is investing in great technologies such as cloud and Watson (artificial intelligence) and it is still priced at a P/E of 13.8 and boosts a dividend yield above 3%. The company is rewarding shareholders handsomely through buy-backs and dividends. We bought shares in IBM in Q1 2016 when they bottomed ($122), and then we bought again in the following months (at $150). Our average price is $136. Considering the current price of $168.68, we have a present gain of 24% plus 3% in dividends.
AmerisourceBergen (ABC): This is also a new position for 2017. As we mentioned in some of our recent articles, we believe that the pharma industry offers good value. Within this industry, drug distributors are a smart and relatively safe play. Pharmaceutical companies are also defensive in case of a market correction. Despite the recent jump in price, ABC still trades at 12.8X 2016 EPS. We bought the shares a few days ago at an average price of $78.53. Considering the stock price of $83.69, we have a current gain of 6.6% in three trading days.
General Motors (GM): We publicly recommended GM at the end of August. At that time, we also started our position. As we mentioned, “the current valuations more than reflect potential uncertainties and do offer value”. After the recent rally, GM is not as cheap as it was, but it still trades at a 2016/2017 P/E of 6. Clearly, in case of recession, automakers are going to suffer. Yet, GM has $24B in cash or equivalents that will shield it from turbulence. We entered our position in August at an average price of $31.91. Now GM shares trade at $36.37 for a potential profit of 14% plus 2% in dividends of $0.76.
American Express (AXP): This company had a difficult 2015 and beginning of 2016. AXP lost a few partnerships, including the one with Costco that represented a significant portion of its revenues. Yet, American Express is still a great brand and operates in a great industry. We are aware of the potential headwinds faced by AXP, but we thought that, back in February 2016, the shares were too cheap to pass. Therefore, we caught the opportunity to become shareholders of an historical brand with a strong management that operates in an attractive industry. We entered our position back in Q1 2016 at the very bottom, at $52. The current price of $75.32 reflects a gain of 44.8% on top of 1.7% in dividends. We like American Express as a long-term quality play. Despite the recent issues, the company is still well managed and the underlying business model is great.
Pets at Home (PHGPY): This company is our largest non-U.S. holding. Pets at Home is a U.K. pet retailer. We like the pet business due to its resilience and stable growth. The company is a market leader in U.K. and, over the last few years, it has grown very rapidly. As we mentioned in our public articles, the company trades well below its peers due to worries about Brexit. We started our position a few months ago at an average price of £2.25. The shares currently price at £2.35 for a potential gain of 4.4% plus 1% in dividends. The company is still conservatively priced and offers a good long term investment thesis. However, some turbulence due to Brexit might be ahead. We hold the London shares so we are also exposed to currency risks.
Gilead (GILD): This investment has been our biggest disappointment in 2016. We started our position at the beginning of the year at $102, we then increased our position by 50% at $85.2, for an average price of $96.4. At current prices ($76.01) we have a potential loss of 20.9%. Having received dividends of $1.41 does not sweeten the pill very much. Our performance would have been worse if Gilead did not have a great start in 2017, gaining 6% in a few sessions. The company is obviously facing steep competition and pricing pressure for its drugs. The market badly wants an acquisition. We are still confident in our investment due to an incredibly low valuation and an historically competent management. We find the management’s resistance to market pressure reassuring. Doing M&A when a company has a large cash position is easy, but doing it in a way that creates value for the shareholders is much more challenging. Gilead proved to be able to make those acquisitions in the past, and considering the sell-off in the biotech sector, having waited to pull the trigger saved the shareholders a lot of cash. We are highly exposed to the pharmaceutical industry so we will not increase our position, but Gilead at $76 offers a compelling case.
Akorn (AKRX): This company is also a recent addition to our portfolio. Again, we feel that the pharmaceutical sector is defensive and offers interesting opportunities. Akorn operates in the generic segment. AKRX had a great start of the year, in line with the pharma industry. We acquired and publicly recommended the company when it was trading at $21.45. It currently trades $23.42, offering us a gain of 9.2% in a few trading sessions. Despite the jump in valuations, AKRX is still very attractive. It is priced at 13.6X 2016 EPS, and 12.6X 2017 EPS. We still recommend starting a position at current market prices.
Bertrandt (BDGXF): This is our second largest non-U.S. holding. Bertrandt is a great German company that provides solutions for the international automotive and aviation industries. BDT increased its revenues from €576M in 2011 to €992M in 2016. The company is solid, well managed and trades at reasonable valuations. It currently trades around 15X 2016/2017 EPS. We entered our position during the Brexit fallout at an average price of €85.7. The current share price of €98 gives us a potential gain of 14.3% in Euros. With Bertrandt we are exposed to the auto industry and to currency risks.
Tegna (TGNA): The company owns a portfolio of media and digital businesses. We invested in TGNA for several reasons. TGNA trades at reasonable valuations. Despite the recent price spike, the stock is priced around 11X 2016/2017 EPS. We also believe that the company is well managed and the future corporate moves will benefit current shareholders. In particular, within a few months, Tegna will spin-off Cars.com. A sum of the parts shows that Tegna is significantly undervalued at current prices. We started our position a few months ago at an average price of $18.5. The shares now change hands at $21.57, therefore incorporating a potential gain of 16.6% on top of 0.7% in dividends. In our opinion, the spin-off of Cars.com will drive the stock price much higher.
EasyJet (ESYJY): This is another U.K.-Brexit investment. EasyJet is a low-cost European airline. In recent years, EasyJet has had an extraordinary run. From 2011 to 2016 it almost doubled its net income to £427M. Clearly it is now facing risks due to political and currency issues associated with Brexit. This damaged the stock, losing 42% of its value in 12 months. We thought that the sell-off was overdone and started a position a few months ago at an average price of £9.09. The current share price of £10.52 provides a potential gain of 15.7%. The stock currently trades at 11X 2017 expected EPS and offers a dividend yield of almost 5%. We still believe that EasyJet is a great company that faces business, currency and political risks. Yet, it is well managed and incorporates a very attractive valuation.
Dunelm (DNLMY): In order to hedge against Brexit risks, we also have a short position in Dunelm. The company is a furniture retailer. If the U.K. faces severe problems, consumer retail will be under pressure.
We see risks for 2017. Yet, we believe that our portfolio and cash position are designed to weather a market downturn. In the long-term, we are confident that our investment strategy will offer attractive risk-adjusted returns.