Mackenzie Global Equity & Income Team
- During Q1 2017, Mackenzie Global Dividend Fund returned 7.4%. This compares with the MSCI World Total Return Index ($CDN) return of 5.3%. The portfolio benefited from stock selection in the United States and in financials. Slight detractors included stock selection in France and information technology.
- Mackenzie US Dividend Fund returned 8.0% during Q1 2017 and has now returned 18.0%, annualized, since inception. This compares with the S&P 500 Total Return Index ($CDN) Q4 return of 5.0% and 17.8%, annualized, since inception of the Fund. Stock selection in consumer discretionary and consumer staples contributed to performance during the quarter.
- Capital markets around the world were more or less uniformly up in the first quarter of 2017. The U.S. stock market, after having been shot out of a cannon following the election on Donald Trump in November as it expected sweeping, immediate legislative change from a Republican-controlled Congress, moderated somewhat from late February onward. The President’s failure to replace and repeal ObamaCare, along with the increasingly slim chance that any legislation on tax reform or infrastructure spending will be enacted before this year’s congressional August recess, has put a damper on the market’s “animal spirits.” And despite the rhetoric, investors are beginning to realize that no matter how much Trump publicly pressures (shames?) U.S.-listed businesses to refocus their efforts on reviving their domestic manufacturing footprint, the proverbial globalization cat is out of the bag. No amount of investment is going to turn the American Midwest into China’s Pearl River Delta. In fact, that region’s logistics and fulfillment network is of such scale that even apparel and footwear manufacturers such as Nike that have moved production to Vietnam are still shipping their products to Shenzhen prior to shipping to the U.S. or Europe in order to hook into that supply chain!
- Outside of North America, there were encouraging signs of growth. In Asia, the Bank of Japan increased their domestic GDP growth estimates in recent months, and China saw an acceleration of industrial production and investment, even as the government pressed on with supply-side reforms with the closure of redundant capacity in heavy industries like steel and cement. The transition from an export-oriented to a consumer-based economy continued to show progress. Europe outperformed North American markets in Q1 2017, as the Eurozone showed ongoing economic improvement. Unemployment continued to fall from a peak of over 12% four years ago to a recent 9.5%, as both Germany and France showed an employment PMI above 50. Consumer and business sentiment are approaching their pre-GFC highs. We believe that the looming specter of the upcoming French and German elections will keep a pall on things until we’ve moved past the polling results. As last year showed everyone, markets have a funny way of keeping us on our toes when it comes to dealing with such unpredictable events. It is our job as capital allocators to not try and predict such event outcomes (which has proven more than futile for even the most esteemed professional prognosticators), but to allow the market to do its work and to take advantage of any pricing dislocations that derive from such outcomes. We have our list of leading global dividend paying companies at the ready.
What contributed positively to performance?
- Broadcom’s strength in the quarter was attributable to the acquisition of Brocade. True to their model, Broadcom showed up to save the business after Brocade management lost their way. Brocade has a legacy fiber business called Fiber Host Bus Adapters, which is used to connect storage devices to host systems. This has been a very profitable business for Brocade; however, the growth in the business has slowed to low single digits. To accelerate growth, Brocade got into IP networking to try to take market share from Cisco. In our view, this was a foolish foray and a misappropriation of capital. Broadcom was happy to buy the legacy business and has announced plans to sell the networking business as Cisco is a big customer of Broadcom in other segments. The deal will be 10-15% accretive to Broadcom’s earnings. The company continues to be a core holding in the Mackenzie Global Dividend Fund.
- Apple returned over 20% last quarter based on a strong quarterly result after its next most profitable competitor (Samsung) incurred sizeable losses from a product recall. And while investors are expecting pent-up demand to result in strong iPhone 8 sales later this year, they are also factoring in the company’s software and services business to account for an increasingly large portion of profit in the coming years. From just over $10 billion five years ago, Tim Cook has set out a $50 billion sales target for this segment by 2021.
- High end Chinese mall operator and property owner Hang Lung Properties Ltd also recovered nicely this quarter as they saw retail sales improve across tier 1 and tier 2 cities, and occupancies tick up.
What detracted from performance?
- Oil commodity prices weakened in Q1 along with the “Trump trade” momentum and as investors fretted about OPEC’s ability to effectively coordinate production cuts among its member nations. Not surprisingly, our only two pure energy holdings, Occidental Petroleum and Schlumberger, underperformed. Fund custodian and ultra-high net worth manager Northern Trust also dragged down performance as higher than expected costs caused margins to come in below expectations this quarter. The theses remain intact and we continue to maintain our position in all three names.
What changes have we made to the Mackenzie Global Dividend Fund?
- The Fund initiated a new position in Philips NV over the course of late 2016 and into the first quarter of 2017. Most people know Philips as the Dutch purveyor of light bulbs and television sets. In fact, the company has completely transformed itself over the years, having sold its audio-visual franchises almost a decade ago. In late 2015, they spun off their consumer lighting business (LIGHT.NA on the Euronext Amsterdam exchange, of which Philips still retains over 50%), and in December 2016, they sold their automotive lighting business to private equity for US$1.5 billion. All told, under the direction of CEO Frans Van Houten, the company effectively sold off half of its business lines – not an insignificant move for a 125 year-old European company. The result is that the company has transformed from a sprawling conglomerate to a much smaller, healthcare-oriented business (if one considers over €17billion in sales “small”) with leadership positions across all its main segments. The “new” Philips is a top three player globally in diagnostic imaging (MRI, ultrasound, image-guided therapy), healthcare informatics (ICU and patient care remote monitoring), and a range of personal care businesses, from power toothbrushes (Sonicare) to male grooming to air purifiers. We believe the company still has several hundred basis points of margin opportunity as its slims down and refocuses on its core, the vast majority of which is of the self-help variety and needs little in the way of underlying market cooperation to achieve. When it’s all said and done, we feel a more focused business with higher margins focusing on faster-growing and more predictable end markets deserves to trade above what one pays for an industrial conglomerate.
- Sabre Corp Holdings operates the largest global distribution system (“GDS”) for travel related purchases. The system is used by 350,000 travel agents, 400 airlines, 100,000 hotels, 25 car rental brands, 50 rail providers, and 14 cruise lines around the world. The system was first created by American Airlines in 1964 when they were looking to automate their reservation systems. The company separated from American Airlines in 2000. GDS allows customers (travel agents) to access inventory and book inventory. The company then charges both the buyer and the seller a fee when a reservation is made. After the separation from American Airlines, the company started investing in brand extensions, which include airline and hotel reservation systems. Similar to GDS, the real-time database, a transaction fee is incurred by the seller of the flight or room when the reservation is made. Furthermore, synonymous to bond rating agencies, customers utilize at least two reservation systems, and 70% use more than two. The company grows in line with passenger miles, which have grown at a high single digit growth rate for the last several decades. The travel network business has very high switching costs, which results in recurring revenue of 91%. Sabre has over 50% market share in the business U.S. and Latin America, and 36% globally. The company is taking share from the incumbent competitor Amadeus in Europe, as Amadeus tries to do the same in North America. This is positive for Sabre because booking fees are slightly higher in Europe versus North America. The company has a new CEO who outlined an aggressive capital spending plan over the next two years. This has created an opportunity in the shares. Investors have been concerned that private equity ran the business for cash and ignored capital investment. We do not believe this was the case; however, any signs of this being the case puts pressure on the shares. At current valuation, we believe this is well priced into the shares of the company. We find that Sabre has large recurring revenues, mid-single digit organic growth rates, and an attractive valuation.
- Companies we sold from the Fund this quarter include drug giant Pfizer Inc. and dental and veterinary distributor Patterson Companies, which we simply replaced with what we believe to be better medium-to-long-term opportunities. Both companies remain on our Dividend Dream Team list.