Cullen North American High Dividend Value Equity Fund: July 2018 commentary

Fund Update
July 2018 Print article
Jennifer Chang Fund Manager
James Cullen Fund Manager

Summary Comments:

U.S. equities increased substantially in the month of July, as the S&P 500 rose 3.7% and the Russell 1000 Value was up 4.0%. Every sector finished the month in positive territory, driven by strong economic growth and another quarter of better than expected earnings. Industrials was the best‐performing sector (+7.3%), as several transportation and capital goods firms posted strong 2nd quarter earnings and fears of an escalating trade war abated late in the month.   Healthcare (+6.6%) was the next best performing sector, partly on news that the Trump administration is considering ways to reduce rebates for pharmacy benefit managers, which could potentially benefit pharmaceutical firms. The Financials sector was up 5.3% in July, as banks are experiencing higher levels of loan growth and received mostly positive reviews from the annual Fed stress test. Real Estate and Energy were the worst‐performing sectors, up only 1.1% and 1.4%, respectively.

With roughly half of the S&P 500 companies having reported 2nd quarter earnings thus far, 83% have exceeded their consensus earnings estimates. Moreover, the average year‐over‐year earnings growth has been 21.3%, the second highest level of earnings growth for a quarter since 2010, trailing only 1Q’18 at 24.8%. The Commerce Department reported 2nd quarter U.S. GDP growth of 4.1%, driven by strong consumer and business spending, as well as an increase in exports. Personal consumption expenditures rose 4% in the quarter, while business investment grew 7.3%. However, investors and economists have expressed concern about the impacts of tariffs and a potential trade war between the U.S. and key trading partners. In early July, tariffs went into effect on $34B of Chinese imports, and China responded with their own tariffs on U.S. farm products. Meanwhile, the European Union threatened tariffs on $300B of imports if the U.S. follows through on threats of automobile tariffs.

Dividend Trends:

During the month of July, two portfolio companies raised their dividend payments with an average increase of +7.6%:

  • Diageo (DEO) raised its dividend payment by +5.0%
  • Wells Fargo (WFC) raised its dividend payment by +10.3%

So far this year, 27 out of 39 portfolio companies have raised their dividend payments with an average increase of 8.0%. This builds on the strength of 2017 where 30 out of 38 portfolio companies raised their dividends with an average increase of +6.8%.

Best Performers:

  1. Corning (GLW) – The shares increased 20.6% during the month. In late July, Corning reported 2nd quarter results that reassured investors. Sales grew 9% year‐over‐year with positive growth across all five business units with their Optical Communications (fiber optics) and Environmental Technologies (auto emission filters) businesses posting the strongest growth. In addition, profit margins recovered from the first quarter report and the management team reiterated their expectation for further improvement in the second half of the year. The company is building out new production plants in the U.S. and internationally to manufacture specialized glass products for various end‐markets, including health care, communications (fiber optics) as well as traditional LCD displays. In addition, Corning continues to expand its presence in new markets such as specialized cover glass for the automotive market. Given the ongoing expansion plan and high‐level of capital investment, investors were relieved to see strong top‐line growth, healthy cash generation as well as a recovery in profitability. Earlier this year, Corning announced a 15.5% increase to its dividend.
  2. Eli Lilly (LLY) – The shares increased 15.8% during the month. Eli Lilly reported 35% year‐over‐year growth in earnings per share for the 2nd quarter and raised full‐year guidance to a range that implies earnings growth between 26‐29%. The company continues to see strong demand for its products across various therapeutic areas such as diabetes, autoimmune disease and oncology. In diabetes, Lilly saw 62% sales growth in Trulicity driven by increased demand as well as market share gains. In autoimmune, Taltz sales grew 59% due to superior efficacy and share gains for treating psoriasis and arthritis. In oncology, Cyramza grew by 17% as demand increased for treatments related to lung cancer and gastric cancer. Lastly, the company announced that it will pursue an initial public offering of the Animal Health business in the second half of this year.
  3. Walgreens Boots Alliance (WBA) – The shares increased 12.7% during the month. After a significant share price decline following Amazon’s announced acquisition of Pill Pack, a small online pharmacy, on fears of Amazon’s disruption of the healthcare supply chain and pharmacies, Walgreens stock recovered in July. While Amazon’s entry remains a threat, there is unlikely to be short and medium‐term risks to the retail pharmacies given their strong relationships with payers and PBMs, their multi‐channel offerings and the complexities of a new player navigating the healthcare landscape. Walgreens reported 2nd quarter EPS growth of 15%, stable U.S. retail pharmacy sales and strong free cash flow generation leading to the announcement of a $10B share repurchase program and a 10% year‐over‐year increase in its dividend. At the current valuation of 10x 2018 EPS with a 2.7% dividend, shares are trading at an attractive valuation and CEO Stefano Pessina executed a large open market purchase in the month. In addition, Walgreens inclusion in the Dow Jones Industrial composite put a bid under shares.

Worst Performers:

  1. Intel (INTC) – The shares declined 3.2% during the month. After having performed strongly in 2018 through May, Intel shares sold off on news that CEO Brian Krzanich will be stepping down. While concerns mount that the company’s delay of its 10nm server processor could lead to market share gains by competitors including Taiwan Semiconductor and AMD, the company expects to begin shipments in 2020. Meanwhile, data center growth continues at a strong pace and the Board is considering a number of strong candidates to step in as CEO, potentially accelerating a significant corporate transformation for the company. Intel trades at 11.8x 2018 earnings with a 2.5% dividend yield.
  2. Royal Dutch Shell (RDS/B) – The shares declined 2.2% during the month. Energy was the second worst‐ performing sector during the month as the benchmark WTI price of crude declined by 7% in July. Shell reported 2nd quarter earnings that fell short of the consensus estimate due to negative currency effects and underperformance of its Downstream business to due higher operating costs. However, with solid free cash flow generation and the near completion of its deleveraging plan, the company announced a $25B share repurchase program. Shell trades at 12.8x 2018 earnings with a 5.4% dividend yield.
  3. Exxon Mobil (XOM) – The shares declined 1.5% during the month. Energy was the second worst‐performing sector during the month as the benchmark WTI price of crude declined by 7% in July. In addition, the second quarter report disappointed as earnings growth (+18%) fell short of expectations. Production volumes were negatively impacted by downtime / maintenance activities and results in refining and chemicals were weaker‐ than‐expected as higher feedstock costs resulted in lower margins. Despite this disappointment, production trends are expected to improve in the second half of the year and management sees sustained growth over the next 3‐5 years with large contributions coming from the Permian Basin in the U.S. as well as several additional projects across the globe. Earlier this year, Exxon increased its dividend by 6.5%.

Thank you for your continued support.

Best regards,

Cullen Capital Management LLC