The upward pressure on bond yields that had been so notable of late was less pronounced over the past week, driven by a confluence of factors that we explain below. Meanwhile, trends on the virus front have deteriorated. The next wave of the pandemic may have less meaningful investment implications this time around given the rollout of vaccines, but it suggests the world is not quite out of the woods just yet.

 

Coronavirus Update

 

Frustratingly, the rate of new infections is increasing once again in some countries. In Canada, the 7-day average rate of new daily infections stands at over 3000 for the first time in a month. The country’s largest province, Ontario, is mostly responsible as it has experienced a noticeable uptick in cases, driven largely by new variants of the virus. But, Manitoba has also seen an increase. Most other provinces have continued to see declines.

 

Meanwhile, parts of Europe are struggling to contain a third wave of the virus that is already well underway. Most notable has been Eastern Europe, with the Czech Republic, Slovakia, Hungary, and Poland all experiencing some of the largest infection rates in months. Even Italy and France are dealing with rising figures. Elsewhere, Turkey, India, and Brazil are all examples of other countries around the world that are contending with rising infection rates.

 

The U.S. continues to experience declines. However, the rate of improvement has slowed, and a few states are now seeing rising trends.

 

Bond yields face some resistance… for now

 

Global bond yields faced a bit of resistance this past week, which provided some support to global equity markets and led some like the Canadian stock market to reach a new high for the year.

 

There were a number of factors at play that helped limit the upward pressure on bond yields. First, the inflation readings out of the U.S. for the month of February were relatively tame, which served to remind investors that the economy is still in the early stages of recovering and that any signs of pricing pressures have yet to materialize.

 

Secondly, the European Central Bank decided to take action to offset the recent move higher in bond yields by committing to buy government bonds at a faster clip, hoping to drive bond yields lower as a result. This adds to a similar decision undertaken by the Reserve Bank of Australia the week before. It underscores the notion that monetary authorities remain focused on ensuring that financing conditions – such as borrowing costs for businesses and consumers – remain very accommodative.

 

Lastly, bond markets were supported by a sizeable debt auction by the U.S. government that went reasonably well. Many governments are issuing increasing amounts of debt to fund the massive amounts of aid and stimulus that have been announced since the onset of the pandemic. This includes the $1.9 trillion stimulus package signed into law by the U.S. administration in recent days. The bond auction resulted in reasonably healthy demand from investors this past week, including large institutions such as pension funds for example.

 

Ultimately, markets were reassured to some extent that inflation is not yet an issue, central banks remain proactive, willing and able to intervene to counteract forces that could jeopardize an economic recovery, and there remains sufficient investor demand to absorb a growing supply of low yielding government bonds, despite inflation concerns.

 

We still expect markets to be tested in the months to come as inflation readings should rise as we lap the spring period from a year ago. The potential to overshoot inflation expectations in the near-term remains a possibility given the high amount of savings, pent-up demand, and new rounds of stimulus. Over the longer-term, we are less convinced that inflationary forces will prevail. As always, we remain vigilant and prepared for any additional market wobbles.

 

Let’s look at some stocks on our radar in the U.S. model.

Consumer Discretionary: Amazon.com, Inc. (AMZN)

Rationale:

• AMZN’s two crown jewels, its core e-commerce and AWS cloud businesses, enjoy strong leadership positions with both markets continuing to benefit from meaningful secular tailwinds. According to JPMorgan, U.S e-commerce penetration as a percent of total U.S. adjusted retail sales stands at only ~20% with e-commerce penetration even lower on a global basis - meanwhile, less than 20% of total workloads exist on the cloud today. We would highlight that AWS is a top 3 global cloud provider with annual run-rate revenues of ~US$50b growing at ~30% year-over-year.
• Long term, we remain constructive on AMZN’s growth outlook predicated on increased share gains in sizeable addressable markets which RBCCM has previously estimated to be a ~$100T across a range of industries including retail, cloud, online advertising, digital payments, gaming, smart homes, health care, logistics and autonomous vehicles. We would highlight that AMZN’s latest foray into space given the announcement of a new Aerospace and Satellite solutions business within AWS has served to further expand the company’s addressable market.
• Valuation: AMZN trades at a forward P/E multiple of 64x, a discount to its long-term average of 138x. We believe the premium valuation is justified in light of the company’s leadership in several secular growth-oriented verticals, and would opportunistically take advantage of the ~6% pullback in the stock.
• ESG: Sustainalytics assigns a Medium Risk rating for AMZN. The company’s overall management of material ESG issues is rated average but this score has experienced positive momentum given steps management has taken to increase its renewable energy program as well as through the hiring of multiple senior sustainability leaders over the past few years.

Technology: Apple Inc. (AAPL)

Rationale:

• We remain constructive on the company’s continued transition towards a services based model (AppStore, TV+, Music, Streaming iCloud, News, Fitness, Arcade) that should help drive margin expansion, increased recurring revenues and a structurally higher multiple. Meanwhile, the company’s core hardware business (iPhones, Macs, iPads) remains a significant generator of free cash flow with iPhones and iPads expected to benefit from the upcoming 5G cycle.
• AAPL boasts a fortress balance sheet in a significant net cash position that offers meaningful optionality as it relates to more aggressive capital allocation and/or potential acquisitions.
• In our view, the potential launch of a crypto exchange business to capitalize on an installed base north of 1.5 billion users or the unveiling of a possible autonomous vehicle offering introduces intriguing upside longer term.
• Valuation: AAPL trades at a forward P/E multiple of 27x, a premium to its long-term average of 15x. We believe that the expansion in AAPL’s valuation over time is reflective of the aggressive transformation of the company’s revenue base towards services alongside wearables and streaming. Such changes drive greater revenue visibility, are margin-accretive and ultimately further bolster the stickiness of the Apple ecosystem. We would use the ~9% pullback in the stock to opportunistically add to the stock, or add to positions here.
• ESG: Sustainalytics assigns a Low Risk rating for AAPL. The company’s overall management of material ESG issues is rated strong given its strict approach to privacy and AAPL’s integration of ESG philosophy across multiple levels of the organization headed by various executives.

Consumer Staples: Coca-Cola Company (KO)

Rationale:

• KO has underperformed the S&P 500 over the past year, down 16% as the company has suffered in the away-from-home channels like restaurants, bars and sports stadiums which represent roughly 50% of revenues and remain fully or partially closed owing to the pandemic induced lockdown. That said, the company is seeing a sequential improvement in its organic revenue growth which came in at -3% Y/Y in the fourth quarter vs. -6% Y/Y in the third quarter and -26% Y/Y in the second quarter.
• KO is currently pruning its portfolio of drinks to focus on the larger ones and make way for innovation with greater potential to scale. Furthermore, KO is improving its advertising spending. Together, we believe these initiatives should enable the company to deliver at the top-end of its growth expectations.
• Valuation: The stock trades at a forward P/E multiple of roughly 21.5x, a premium to its long-term average of roughly 19x. KO is a dividend aristocrat and offers a dividend yield of 3.3%. We would be buyers of the stock at the current price. We like KO as a recovery play into an improving economy.
• ESG: Sustainalytics assigns a Medium Risk ESG Risk Rating Score for KO. Key concerns include the growing prevalence of obesity and diabetes across the globe as well as KO being a contributor to the global plastic waste crisis and depleting water reserves in local communities. The company’s overall management of material ESG issues is rated average, but bordering on being strong.

Real Estate: Crown Castle International Corp. (CCI)

Rationale:

• CCI is one of the leading players in the duopolistic Towers segment in the U.S. As of the end of 2019, the company operated ~40,000 towers and 80,000 route miles of fiber in the U.S. and Puerto Rico.
• The company’s legacy tower business represents 70% of total sales. These revenues are recurring in nature and highly visible as a result of master-lease-agreements (MLAs) that have average durations of 6 years with built-in price escalators of ~3% on an annual basis.
• The legacy towers segment is also the beneficiary of an explosion in mobile data use, which has been growing at a 30-40% rate per year in the U.S. In order to meet the demand, carriers either locate equipment on additional towers or add or modify equipment on existing towers. This represents significant operating leverage for CCI as the costs of the towers are essentially sunk – additional tenants and equipment upgrades can be added to towers for little incremental cost. As demand for data grows over time, the pace of revenue growth for this segment should increase.
• In contrast to its key competitor American Towers Group (AMT) that has operations in foreign and emerging markets, CCI is domestically focused and operates exclusively in the U.S. Further, the company is aggressively investing in fiber to pursue small-cell communications sites (AMT is not).
• CCI has posted a 19.6% CAGR in dividend growth over the last five years. Based on FactSet estimates, the company is expected to grow dividends by ~9% over the next year. This is also a yield oriented stock with a dividend yield of 3.5% or a 120bps versus AMT.
• Valuation: CCI trades at a 25x P/AFFO multiple on RBCCM’s 2021 AFFO multiples – versus the Tower average of 26.4x and in-line with AMT. Notably the Towers REITs will trade at a premium to the broader REITs space as a result of the former’s leverage to key secular growth trends such as the Internet of Things, and explosive growth in the demand for data.
• ESG: Sustainalytics allocates a Low Risk rating for CCI, though moderately above the subindustry (REITs) average. The company’s overall management of material ESG risk issues are deemed to be average by Sustainalytics.

Industrials: Lockheed Martin (LMT)

Rationale:

• LMT is the global leader in defense, and prime contractor on the F-35 program and its missile business.
• The company wide book-to-bill of 1.4 and record backlog of $150b provides healthy revenue visibility and signals that the demand environment for LMT has not been affected by the COVID-19 pandemic over the short term.
• While there is potential for a flattening of the budgetary environment going forward that could weigh on sentiment for the defense stocks, a secular shift in the national defense strategy to modernize the military is likely to partially offset any hypothetical declines in defense spending.
• The company has a balance sheet that is virtually leverage free, and has strong free cash flow conversion. LMT has an attractive yield of ~3.1%, and has grown its 5-year dividend CAGR by ~10%.
• Valuation: LMT trades at a 12.8x P/E on consensus forward EPS estimates, a discount to peers such as Boeing Inc. (BA), and General Dynamics (GD) and Raytheon Technologies (RTX), as well as to its long-term average.
• ESG: Sustainalytics assigns a Medium Risk rating for LMT, though it is ranked better than more than 80% of its Aerospace peers. The company’s overall management of material ESG issues is rated strong.

Technology: Mastercard Incorporated (MA)

Rationale:

• As the economic recovery gains steam, we expect MA to benefit from both a higher average dollar value per transaction as well as a greater frequency of transactions. In particular, we believe cross-border fees, which has been a meaningful drag on earnings over the last several quarters, could potentially witness an inflection point as early as late 2021 as a greater proportion of the world’s population is vaccinated and global travel gradually resumes.
• Longer term, MA remains the beneficiary of a secular shift away from cash transactions and towards multiple digital payment flows which the company has estimated to be a $235 trillion dollar opportunity spread across the P2P (peer-to-peer), B2B (business-to-business), B2C (business-to-consumer) and G2C (government-to-consumer) verticals.
• Valuation: MA trades at a forward P/E multiple of 42x, a premium to its long-term average of 26x. We believe the valuation is justified given MA’s dominant position as one of the two largest network associations in the world (MA and V combined represent ~75% of global credit card transactions) which allows MA to generate very high margins and remarkably consistent free cash flow. In addition, we believe this premium will remain well supported given the market’s recognition of the company’s significant secular opportunities which should help sustain an attractive growth cadence longer term.
• ESG: Sustainalytics assigns a Low Risk rating for MA. Key concerns include the company’s exposure to varying levels of regulatory, legal and operational risk given its importance as an intermediary in the financial system. The company’s overall management of material ESG issues is rated strong.

Health Care: Amgen Inc. (AMGN)

Rationale:

• A global biotechnology company focused on the development, manufacturing, and commercialization of novel bio-therapeutics primarily in cancer, nephrology, inflammatory diseases, cardiovascular diseases, and bone diseases.
• The company has grown its dividend annually since 2011.

 

Technology: Texas Instruments Inc. (TXN)

Rationale:

• A global, vertically integrated producer of analog and embedded processing semiconductors.
• Some of the company’s key end markets include industrial, automotive, communications infrastructure, and enterprise systems.
• TXN has paid a dividend every year since 1962.

Health Care: UnitedHealth Group Inc. (UNH)

Rationale:

• A leader in U.S. health care management, provides a broad range of products and services, including HMOs, POS plans, PPOs, and managed fees for service programs.
• UNH paid its first dividend in 1990, growing it each year since 2010.

 

Enjoy the beautiful weather coming our way sooner rather than later.