Brendan Caldwell, president and CEO, Caldwell Investment Management
FOCUS: North American large-cap stocks
Top Picks: Xylem, Vertiv, Qualcomm
MARKET OUTLOOK:
The market has done quite well so far this year, maintaining its strong momentum from last year despite the economic and geopolitical uncertainty. The optimism primarily stemmed from an increased perception that the U.S. Federal Reserve had been able to suppress inflation without causing a full-blown recession and therefore could start cutting interest rates. The strength of the labour markets, coupled with the continued gross domestic product growth, also provided further support to the market’s confidence, helping alleviate the fear of recession.
However, the expected aggressive rate cuts have not materialized and the outlook for the economy now suggests that the Fed may maintain higher interest rates longer than initially expected. This scenario poses a risk of disappointment for investors who anticipated more aggressive rate cuts. The current high valuations further complicate the picture, as they require robust earnings growth to justify current price levels.
Concerns are mounting over whether companies can deliver the necessary earnings to support these valuations. The market now seems to have started pricing in a slightly weakened sentiment as evidenced by the recent pullback, which may persist as we progress through the year if earnings expectations are not met going forward, and if inflation and interest rates do not move in the desired direction. This prompts us to maintain our focus on identifying high-quality, well-managed companies with proven track records of navigating through tough environments. Hence, we believe that professional investment advice can be extremely valuable in times such as these.
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TOP PICKS:
Xylem (XYL NYSE)
XYL is a pure-play water products company. It sells products that transport, treat and clean water – think pumps, valves, waste/stormwater pumps. Also, it sells residential and commercial utility meters, including connected meters that allow utilities to track customers’ water usage more precisely.
Its long-term secular story is driven by scarcity (global population growth, controlling “non-water” revenue i.e. leaks), reliability (natural disaster preparation/damage control, water quality monitoring) and resilience (upgrading existing water infrastructure).
It benefits from infrastructure stimulus as municipal water utilities upgrade dated infrastructure and deploy smart meters (where penetration is still only around 70 per cent in highest penetration markets); international penetration lags North America.
It has a new management team that has implemented an efficiency plan to simplify SKUs and place greater focus on higher-value customers. Operating margins should expand driven by more disciplined price-cost, operational productivity improvements implemented through the pandemic, mix shift to higher margin digital services, volume leverage in the previously hampered MC&S segment and Evoqua cost synergies. There are potential revenue synergies from the Evoqua deal that are showing early signs of promise.
Vertiv (VRT NYSE)
Vertiv is a global leader in cooling products that ensure the smooth, consistent operation of data centers, communications networks and other industrial processes. Power and permitting constraints in building/expanding data centers support longer order lead times from large customers and thus better MT/LT visibility.
We see a potential upside to long-term growth guidance driven by very robust hyper-scale data center capital spending (seeing this play out in significant backlog growth in AI-related projects in the first half of the year).
There is margin improvement from operational leverage (new CEO has done a good job improving operational execution, previously serving as COO) and a positive pricing environment (this should improve along with the shift to more expensive servers over time).
There is an upside to growth targets from mergers and acquisitions. VRT expects to deploy around $3.5 billion on mergers and acquisitions over the next five years, primarily bolt-on deals but has strong CF and debt capacity to do larger deals.
Continued deleveraging supporting credit rating upgrades - VRT is still non-investment grade but recently upgraded to two notches below IG status.
Qualcomm (QCOM NASD)
It is a leading global semiconductor company historically known for communications network protocols and smartphone chips but rapidly growing adjacent verticals in automotive, industrial and PCs.
Recent data points suggest the global smartphone market has bottomed and has returned to positive growth. Edge AI, which runs locally on a device, rather than the cloud, will drive a mix shift to higher-priced smartphone devices where QCOM has been gaining share. The desire to leverage newer AI updates in Apple/Samsung devices could drive a stronger-than-usual device upgrade cycle in the next 12-24 months
PCs are a potential new growth driver (edge AI also at play) with the promising performance of new Snapdragon Elite-enabled laptops. Increasingly attractive MT/LT growth contribution from Auto, IoT.
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| XYL NYSE | N | N | Y |
| VRT NYSE | N | N | Y |
| QCOM NASD | N | N | Y |
PAST PICKS: JULY 17, 2023
Entegris (ENTG NASD)
- Then: US$111.74
- Now: US$127.63
- Return:14%
- Total Return: 15%
ESAB (ESAB NYSE)
- Then: US$69.13
- Now: US$100.03
- Return:45%
- Total Return: 45%
Vulcan Materials (VMC NYSE)
- Then: US$223.71
- Now: US$268.54
- Return:20%
- Total Return: 21%
Total Return Average: 27%
| DISCLOSURE | PERSONAL | FAMILY | PORTFOLIO/FUND |
|---|---|---|---|
| ENTG NASD | N | N | Y |
| ESAB NYSE | N | N | N |
| VMC NASD | N | N | Y |
