Peattie Capital

Income accounts performing well

Peattie Capital portfolios diverged in June, with income oriented portfolios clearly the best performers. Interest rates are falling everywhere, and Fitch reported last week that $11.7 trillion of sovereign bonds were trading with yields below 0%. Needless to say, the demand for income continues. Thus far in 2016, fixed income is providing the best capital appreciation, and equities are providing the best income.

While I'm hard-pressed to make the case for bonds, which I consider "return-free risk", I have been adding several bank preferred stocks to a number of portfolios. Several of these have attractive dividends in the 5% - 7.5% range, and the major money center banks have plenty of liquidity to make the payments.

Overall, the first half of the year has been disappointing for Peattie Capital portfolios as a couple core positions have performed very poorly and protecting against a further selloff after the year's volatile start left several accounts underinvested when the market turned up. For most accounts, even ones I consider somewhat aggressive, I expect to emphasize more income producing names. The NASDAQ has dropped 3.7% year- to-date, well below both the S&P 500 and Dow.

A tale of two markets

Defensive sectors (utilities, REITS, consumer staples) have significantly outperformed however many names in those sectors now trade too expensively to buy. For example, General Mills ("GIS") reported last week, and shares bounced to $72, up 27% for the year. Despite declining revenues (and no revenue growth expected until 2019), shares trade at 23x fiscal 2017 earnings estimate of $3.10 and 21x fiscal 2018 estimate of $3.45. To be sure there are improving margins, and a dividend of $1.92 (2.6% yield) so there are reasons to like the stock. Several conservative accounts own Pepsi ("PEP") although at 18x it too is trading at a premium to the market.

In contrast, CommScope ("COMM") a $6bn global communications infrastructure company, has grown revenues at a compound annual growth rate ("CAGR") of 14% the past 10 years, and 9% the past five years. The company expects 9%-14% revenue growth annually for the forseeable future. Adjusted operating income was $311mn in 2011 and is expected to be over $1bn in fiscal 2016, a CAGR of 22%. Adjusted free cash flow is expected to be over $500mn in fiscal 2017, a CAGR of 13% during the same period. Earnings were $1.85 in 2015 and are expected to be between $2.40-$2.50 in 2016, for growth of over 30%. Granted the shares have also performed well this year, but at $30 they still represent a good opportunity at barely 12x forward earnings. Mobile data traffic grew 74% in 2015 and is expected to grow another 9 fold by 2020. (Note: company May 16 presentation for all data)

There is no telling when this disparity will end, but given the variety of uncertainties my guess would be it will continue for now.

Two names punished by Brexit

In June, two names were hit hard by the Brexit vote, Ryan Air ("RYAAY") and Epam Systems ("EPAM"), both of which dropped roughly 20% and so far haven't recovered. I particularly like the long term propsects for RYAAY, which is already moving to increase the size of its share buyback program and currently trades at roughly 9.5x 2017 estimates, about half the S&P's 17x forward estimate. Near-term there are a number of uncertainties, but mid and longer term RYAAY is a very attractive opportunity. That said, holding these names may not be appropriate for all Peattie Capital accounts.

According to Sam Stovall at Standard & Poors, usually there are several days of selling after a surprise like the Brexit vote, with a 6-8% drop fairly typical. Following that, however, markets tend to recover and reclaim the losses over the ensuing weeks, possibly months. Not so in the volatile 2016 markets, as the S&P 500 dropped 113 points (-5.3%) in just two sessions and subsequently regained 98 points in the following three sessions (uses closing prices). For the month the S&P was essentially flat, gaining two points to 2098.

I have been asked how the markets could rebound so quickly, and the only thing I might ascribe that to would be the likelihood that domestic interest rate hikes would be pushed further out, and the ongoing demand for fixed income and corresponding drop in rates makes equities more attractive on a relative basis. Other possibilities might be that Brexit will not actually happen for a couple years, and even when (if?) it does it may not have a material impact on earnings for US companies.

Early prognosis on new research partner is good

I mentioned last month that I had begun receiving regular research reports from a group that I've been working informally with for a few years and I'm pleased to say that early reviews are good.

By way of background, this group runs a portfolio (not open to outsiders) which consists of 15 long positions and 15 short ones. They host regular meetings, forums, panels and "Idea Days" with a variety of investors, industry specialists, research analysts and other financial professionals and look at 400-500 companies annually. From this they create a "funnel" of potential investment candidates, and then they do their own proprietary research to create a "bench" of names ready to go into their portfolio. The result of this procedure is a "competition for capital" as they are disciplined about the structure of their portfolio, with only the very best ideas actually being in the portfolio.

Recently four of their long positions reported earnings and each beat estimates, with an immediate bump to the share price (albeit short-lived in one case), and they were not immune from the Brexit selloff. Still, my confidence in this group is growing, and I believe that Peattie Capital and its clients will benefit from being part of their community.

US Economy still ok

Overall the US economy remains stuck in the 1.5-2.5% range, which is better than many areas of the world, but not terribly inspiring. The good news is that the likelihood of a recession appears low, but after so many years of such low interest rates, it's surprising that growth isn't stronger. In addition, no one knows what the Fed might be able to do to combat a recession should one happen.

From an earnings perspective, it's helpful that oil has rebounded (for now, at least) and the US dollar isn't appreciating like it did last year, although it is stronger since the Brexit vote. Both these factors are helpful to many US companies.

Stock picking is still a good way to go

Peattie Capital believes that paying the right prices to own the right stocks is a good approach to the market. For some clients, depending on their specific characteristics, I might also overlay a tactical hedging program to protect against material downdrafts which might consist of boxing existing long postions, shorting, or raising cash.

For long term investors, I (generally) agree with Warren Buffett's comment that "All there is to investing is picking good stocks at good times and staying with them as long as they remain good companies." That is still the approach for most, not all, Peattie Capital clients as difficult as it is sometimes.

Here is an updated version of recent Peattie Capital recommended stocks, using closing prices from June 30.

This chart shows all PCM's recommendations for the past 18 months showing an average return of 10.3%. The total return of the S&P 500 in the comparable period is approximately 4.9%.

Additional recommendations are available on request. This table does not include speculative
and short sale candidates which are only appropriate for clients who have requested them.