Cullen North American High Dividend Value Equity Fund: January 2019 commentary

Fund Update
January 2019 Print article
Jennifer Chang Fund Manager
James Cullen Fund Manager

Summary Comments:

Following the worst December for the S&P 500 since 1931, stocks rebounded with the index posting its best January in 32 years. For the month, the S&P 500 and Russell 1000 Value returned 8.0% and 7.6%, respectively. Every sector finished in positive territory, led by Industrials (+11.4%), which rebounded from concerns in December of slowing global growth and a China trade war. The next best performing sector was Energy (+11.1%) as the WTI oil benchmark increased 18% for the month, finishing at $53 per barrel. Real Estate (+10.8%), Communication Services (+10.4%) and Consumer Discretionary (+10.3%) all posted double-digit percentage gains for the month. The defensive Utilities (+3.4%), Health Care (+4.8%) and Consumer Staples (+5.2%) sectors were the laggards, although all three posted strong monthly gains.

After raising interest rates 0.25% in December, Fed Chair Jerome Powell said at the outset of 2019 that the central bank “will be patient” in its approach to monetary policy, and that there is no preset path to raising rates. The Fed also indicated it may curtail the pace at which it reduces its balance sheet holdings, and may even maintain a larger portfolio of Treasurys and mortgage-backed securities than previously expected. Stocks also got a boost early in the month when the Labor Department said 312,000 jobs were added in the US in December, the highest figure in almost a year, and that hourly earnings increased 3.2% in 2018, the biggest full-year gain in a decade. The positive news items offset a host of negative developments in January, including the longest Federal government shutdown in US history. After feuding for weeks over funding for a border wall, President Trump and House Democrats reached a deal to temporarily reopen the government for three weeks. On the international front, British Prime Minister Theresa May’s Brexit plan was defeated in the House of Commons, leaving the UK without an exit plan from the EU with only two months remaining. In China, the government announced GDP growth of 6.6% in 2018, the country’s lowest growth rate in 28 years. Finally, the IMF reduced its forecast for global growth in 2019 to 3.5%, down from 3.7% forecast in October and the 3.9% forecast it issued in July.

Dividend Trends:

During the month of January, eight portfolio companies raised their dividend payments with an average increase of +3.8%:

  • AT&T (T) raised its dividend payment by +2.0%
  • Chevron (CVX) raised its dividend payment by +6.3%
  • Diageo (DEO) raised its dividend payment by +1.8%
  • Intel (INTC) raised its dividend payment by +5.0%
  • Kimberly-Clark (KMB) raised its dividend payment by +3.0%
  • Novartis (NVS) raised its dividend payment by +1.8%
  • Pfizer (PFE) raised its dividend payment by +5.9%
  • Wells Fargo (WFC) raised its dividend payment by +4.7%

 This builds on the strength of 2018 where 31 out of 37 portfolio companies raised their dividends with an average increase of +10.6%.

Best Performers:

  1. Boeing (BA) – The shares increased 19.6% during the month. The Industrials sector led the strong rally off the December market sell-off. In late January, Boeing reported strong fourth quarter results with full year revenue and EPS growth of 8% and 30%, respectively; increased 737 and 787 deliveries and higher operating margins drove the results. For 2019, management projects 8% revenue growth and 25% EPS growth driven by higher deliveries coupled with manufacturing efficiencies in the commercial aircraft and defense businesses. Boeing’s current backlog represents seven years of production and given the projected strong growth in passenger miles over the next several years, new routes in emerging markets and replacement demand for the aging global fleet, the company expects strong growth into the next decade.
  2. SunTrust Bank (STI) – The shares increased 17.8% during the month. The severe sell-off in Financials late last year reversed with bank stocks rallying into earnings on lowered market expectations. In January, SunTrust reported better-than-expected fourth quarter results driven by strong loan growth and efficiency improvements. While net interest margins were stable, credit quality remains benign and the company expects further loan growth and cost cutting to drive earnings growth. Over the next year, SunTrust is expected to exit from Federal Reserve oversight and the annual bank stress tests with its current asset level falling below the ultimate oversight threshold. This will allow the bank to release excess capital through dividends and buybacks.
  3. Phillip Morris International (PM) – The shares increased 14.9% during the month. 2018 was a difficult year for tobacco investors due to regulatory concerns as well as disruption caused by new products. In 2018, Philip Morris’ stock saw its first double-digit percentage decline since the financial crisis and traded to a low valuation level of 12.5x projected earnings, a 15% discount to the S&P 500. Within this context, the stock experienced a relief rally in January as global markets recovered. While the tobacco industry is undergoing disruptive changes, these changes have yet to damage PM’s business model. The company has been a strong innovator with its popular IQOS device, offering a smoke-free alternative to cigarettes in more than 40 countries around the world. Over the last two months, PM has been rolling out its next generation IQOS device; while expectations are high, we believe the core cigarette business will continue to generate strong profitability. Philip Morris’ dividend is safe in our view and the current yield and valuation are attractive.

Worst Performers:

  1. Merck (MRK) – The shares declined 2.6% during the month. Health Care, particularly Pharmaceutical stocks, underperformed in January after being the top performing sector in 2018. Rotation out of stable sectors and into more cyclical parts of the market was a dominant factor in January. With House Democrats, Senate Republicans and the White House evaluating proposals to lower pricing on high-priced drugs, sentiment deteriorated for the industry. While there are a number of proposals focused on drug price reform, most do not appear to significantly harm core Medicare and commercial net pricing and instead are focused on niche markets as well as drug supply chain middlemen. Recently, HHS Secretary Alex Azar, a former Eli Lilly executive, formally proposed to eliminate pharmacy benefit manager (PBM) rebates and instead negotiate upfront drug discounts to allow savings to flow directly to the consumer for Medicare Part D drugs. The anticipated impact on pharmaceutical companies, while not exactly known, is expected to be neutral/positive. Merck continues to deliver on growing its oncology and vaccines business with annualized sales of Keytruda, its leading immuno-therapy, running at over $8B in sales. In addition, the company has a number of pipeline drugs that offer strong upside potential.
  2. Kimberly-Clark (KMB) – The shares declined 2.3% during the month. Kimberly Clark’s fourth quarter earnings release showed slow top-line growth, disappointing investor expectations. Rising competition in addition to weakening global growth have had an adverse impact on the company’s emerging markets business (mid-single digit growth rate) while developed markets continue to grow at a low rate. The company’s strength lies in its core brands, which have retained their #1 or #2 status globally, and pricing power has seen a positive inflection in recent quarters as the industry is becoming increasingly rational. While volume growth is expected to remain sluggish, we believe that a firmer pricing environment will enable the company to deliver earnings growth for 2019. During the month, Kimberly Clark announced a 3% increase to the dividend, representing the 47th consecutive annual increase.
  3. Pfizer (PFE) – The shares declined 1.9% during the month. Health Care, particularly Pharmaceutical stocks, underperformed in January after being the top performing sector in 2018. Rotation out of stable sectors and into more cyclical parts of the market was a dominant factor in January. With House Democrats, Senate Republicans and the White House evaluating proposals to lower pricing on high-priced drugs, sentiment deteriorated for the industry. While there are a number of proposals focused on drug price reform, most do not appear to significantly harm core Medicare and commercial net pricing and instead are focused on niche markets as well as drug supply chain middlemen. Recently, HHS Secretary Alex Azar, a former Eli Lilly executive, formally proposed to eliminate pharmacy benefit manager (PBM) rebates and instead negotiate upfront drug discounts to allow savings to flow directly to the consumer for Medicare Part D drugs. The anticipated impact on pharmaceutical companies, while not exactly know, is expected to be neutral/positive. Toward the end of January, Pfizer reported healthy results for the fourth quarter, causing the stock to rally 7%+ into month end. Ibrance, a leading breast cancer treatment in its class, grew sales by 32% in 2018 reaching $4.1B in annualized sales. Pfizer also benefitted from strong growth across products addressing diverse therapeutic areas.

Thank you for your continued support.

Best regards,
Jim Cullen – Portfolio Manager
Jennifer Chang, CFA – Portfolio Manager