U.S. equity roundtable: Managers expect aerospace stocks to gain altitude

Janet Navon, managing director, director of research and member of the U.S. investment team at New-York-based Epoch Investment Partners Inc. Epoch manages assets for Toronto-based TD Asset Management Inc. and CI Investments Inc. Epoch’s funds managed include TD U.S. Large-Cap Value, TD U.S. Large-Cap Value Class, CI American Value and CI American Value Corporate Class.

Q: Let’s talk about the industrial sector, which represents 10.8% of the S&P 500 Index. This sector performed well in the year to date.

Navon: We still have a significant holding in Boeing Co. (NYSE:BA). It’s been a strong performer this year. There was a fair amount of investment by Boeing to bring its Boeing 787 to fruition. But now the company is starting to reap the benefits of this in the form of cash-flow generation. We think that this aircraft cycle can last longer than has been the case in past cycles.

Fortin: We have United Technologies Corp. (NSYE:UTX), which we’ve owned for 13 years. The company owns aircraft-engine manufacturer Pratt & Whitney, Otis elevators and Carrier climate-control products. These are its three jewels. They are global businesses with high margins. United Technologies has a strong record of returning cash flow to shareholders.

Navon: We also own United Technologies. We’ve owned the stock for a few years. The company is benefitting from this aircraft cycle. It should also benefit from a pick-up in commercial construction. Another stock that we own that also benefits from the aircraft cycle is Rockwell Collins, Inc. (NYSE:COL). This company produces a range of products and systems for aircraft manufacturers.

Young: We own Parker-Hannifin Corp. (NYSE:PH), a leading global diversified manufacturer of motion and control technologies and systems, and Ametek Inc. AME , a leading global manufacturer of electronic instruments and electromechanical devices.

	Boeing Co.	Parker-Hannifin Corp	United Technologies Corp.
Dec. 4 close	$131.50	$116.71	$108.94
52-week high/low	$142.00-$72.68	$120.12-$80.15	$112.46-$79.34
Market cap	$98.8 billion	$17.4 billion	$100.0 billion
Total % return 1Y*	80.2	46.0	38.7
Total % return 3Y*	27.2	13.0	13.5
Total % return 5Y*	29.0	26.9	20.2
All figures in U.S. dollars
*As of Dec. 4, 2013
Source: Morningstar

Navon: These two companies are also benefitting from the aircraft cycle.

Young: Both companies do have a fairly large aerospace business. The aerospace theme is a good theme and all suppliers to these companies are benefitting.

Q: The consumer-discretionary sector, which represents 12.6% of the benchmark, has put up an excellent performance so far this year.

Navon: You have everything from the auto companies to the cable companies in this sector.

Fortin: Stocks that are housing-related or auto-related have had a phenomenal year.

Navon: Among the retailers, there is a real split between what is doing well and what is not. Here one of our larger holdings is TJX Cos. Inc. (NYSE:TJX). The company is an off-price retailer of apparel and home goods under a number of banners in the United States, Canada and Europe. This stock has been a star. We’ve held it for a while. As U.S. housing has improved, TJX’s home-goods stores have been a real contributor to both its profitability and its growth. The company, as we discussed earlier, is a dividend grower. It has raised its dividend year in and year out and it has also repurchased shares. The stock is more expensive than when we bought it, but we still like it.

Fortin: The biggest consumer discretionary holding in our portfolio is TRW Automotive Holdings Corp. (NYSE:TRW), an auto-parts supplier, which has benefited from the rebound in the auto sector. We bought the stock in July of 2011, when there were concerns that we were entering a double-dip recession. TRW specializes in safety products, including air bags. The stock has done well, but we still like it. It doesn’t pay a dividend, but it has been buying back its shares fairly aggressively.

Young: In this sector, I own The Walt Disney Co. (NYSE:DIS); Nordstrom Inc. (NYSE:JWN); and The Gap, Inc. (NYSE:GPS). Disney has a couple of stable businesses, its sport franchise and its children’s franchise. This generates a lot of cash flow, which it has been investing in new products. It’s building Shanghai Disney and is in a big investing phase. Once Shanghai Disney is completed in 2015, its free cash flow will rise from about US$4.5 billion to US$9 billion a year.

The Gap cut its market cap in half by buying back half of its outstanding shares in advance of improving profit margins and improving comparative store sales. This was a brilliant move because when everything started to work, there was huge leverage for investors and the stock doubled.

Navon: The Gap has always been a huge cash-flow generator.

Young: Yes. Nordstrom is a higher-end merchandiser. The company does a good job of this, because it provides service along with the higher prices. Nordstrom is coming to Canada.

Q: Let’s have a brief discussion of U.S. consumer staples, which represent 10.2% of the benchmark and had a reasonable run in the year to date.

Young: I own PepsiCo (NYSE:PEP). It’s a great snack-food and beverage company. Beverages don’t grow as fast as snack food, but they throw off a lot of cash, and that has funded the growth.

Navon: We also own PepsiCo. This difference in its two businesses could provide the basis for the company to be split. We think the sum of the pieces is worth more than the whole.

Fortin: The staples sector has been the focus of activists this year. So many of these businesses are diversified and some of the assets have been under-managed. Our two biggest names in this sector are Mondelez International Inc. (Nasdaq:MDLZ), which has a global snack-food business, and Kraft Foods Inc. (Nasdaq:KFRT), which owns a North American grocery business. These two companies were the result of a split in October 2012. Kraft pays a good dividend

Q: Finally, it is time to talk about the financial sector, which has put up a good showing for the year to date. Financials represent 16.1% of the benchmark. There has been much written about the recent US$13-billion settlement paid to the U.S. government by JPMorgan Chase & Co. (NYSE:JPM).

Fortin: JPMorgan is a top-10 holding. The bank has a dominant and diversified global franchise with a strong capital base. It’s in good shape, even with this penalty. We bought the stock when it was trading at a discount to its book value. The thesis was that JPMorgan would be able to manage whatever penalties it faced, as a result of the company’s acquisitions and its activities during the financial crisis. As we have come out of this recession, the strongest in a number of sectors have just become stronger. JPMorgan is an example of this in the financial-services sector.

U.S. financial regulation is so stringent. The largest players are now well capitalized. It’s hard for them to grow loans. Their return on equity has been improving. We don’t think the valuations reflect that yet. That’s why we’ve been adding names. We added BB&T Corp. (NYSE:BBT), which is a traditional, conservatively run regional bank. It’s our biggest financial position.

Navon: We’re mostly invested in non-bank financials. Our biggest holding in financials is BlackRock Inc. (NYSE:BLK), which is the leading player in passive investment. There has been a big move to ETFs and this is a business where the economies of scale are great. Blackrock certainly has scale.

For the first and second installments of this roundtable, see the special feature U.S. equity roundtable