12/15/2018

AFG’s High Dividend (HD) Focus List 18Q3 Review

About AFG’s High Dividend (HD) Focus List:

The AFG’s High Dividend (HD) Focus List aims to recommend a list of 25-35 undervalued equities in the US (may include ADRs) that offers attractive dividend yields. This list has both dividend income and capital appreciation characteristics, as opposed to seeking pure yields. As such, AFG’s HD is diversified across GICs sectors if equities meeting HD’s Buy criteria are available in each of the sectors. In addition, no sector counting for more than 30% of the total stock count targeting low turnover.

2018 3rd Quarter Review

AFG’s HD returned 8.32% in calendar 18Q3, vs. 5.78% for its benchmark Vanguard High Dividend ETF (VYM), and 7.42% for the R1000, outperforming by 255 bps and 90 bps respectively.

It is particularly gratifying to see our high dividend strategy outperformed the large cap. index the R1000 in a rising interest rate environment. In the third quarter, the US 10 Year Treasury yield rose from 2.85% to 3.06%, driven by very upbeat US economic data and conviction the US Fed will continue its pace of interest rate hikes. US large cap. equities managed to post strong performance despite rising rates, as investors focused on strong US economic growth, low unemployment, mild inflation, and robust corporate revenue and earnings growth. The Healthcare sector, a traditionally defensive and high dividend paying sector, was the best performing sector in the R1000 index in Q3. The sector’s solid fundamentals, noncyclical nature, and minimal exposure to the ongoing and potentially accelerating US-China trade friction, provided investors a perfect haven to seek growth and downside protection.

Four of the top six best performing stocks in the HD for Q3 are from the Healthcare sector. Eli Lilly (LLY) and Pfizer (PFE) reported strong 18Q2 results, and increased their FY18 guidance. Both companies have spent heavily on R&D and enjoy a balanced portfolio and new product cycle which will likely keep both companies growing their revenues in low to mid single digits every year in the mid-term future. Though the political climate is not most conducive to drug prices, both companies have announced their resolve to grow revenue focused on volume rather than price increases. For Abbot (ABT), the company also reported better than expected 18Q2 revenues and earnings, and raised its FY18 outlook. Later in September, Abbot also reported that its heart failure device MitraClip met both main and secondary goals, including reducing all-cause mortality through 2 years, in its COAPT trial. This development was an unexpected but pleasant surprise, which could provide significant growth opportunity for Abbot in the coming years. Combined with very strong growth in its diabetes business, Abbot is expected to deliver annual revenue growth in the high single digit in the mid term future.

Walgreens (WBA) shares rebounded this quarter as the overblown worries of Amazon entering the retail pharmacy space subsided. In addition, investors likely gained more confidence in Walgreens’ standalone business model, which could potentially allow the company more flexibility for partnerships or joint ventures with additional healthcare services providers. So far, Walgreens has announced partnerships with Humana, in which Partners in Primary Care, a wholly-owned subsidiary of Humana, will operate senior-focused primary care clinics within two Walgreens stores. Walgreens has also been working with Lab Corp for diagnostic services, with UnitedHealth on MedExpress/urgent care, with Starkey for hearing aids, as well as other partnerships with Fedex and Sprint. Norfork Southern (NSC) and the US railroad industry are uniquely exposed to the domestic macro economy. Pricing gains and volume growth are strong, partly helped by an extremely tight trucking market. NSC remains focused on achieving $650 million in efficiency savings and a sub-65% operating ratio before 2020, vs. 67.4% in 2017.

On the detracting side, General Motors (GM) was the biggest loser and shed nearly 14% of its market value in Q3. Headwinds are strong for the auto manufacturer and the company lowered its guidance after reporting 18Q2, cutting adjusted FY18 EPS to $6 from “mid $6” and lowered adjusted automotive free cash flow from $5 billion to ~$4 billion. External headwinds include higher than expected commodity prices in steel and aluminum, and currency devaluation in the Argentine peso and Brazilian real. More importantly, though GM China delivered record vehicles in the first half of 2018, worries were abundant that the escalating trade tension between the US and China is having a material impact on China’s overall economy. GM being the US automaker with the biggest exposure to China, will likely feel much pain. On October 9, GM reported its China sales declined 15% in Q3 from the year ago period, amid softening market. We continue to believe GM is one of the best positioned automakers longer term, and its technology portfolio is promising, which includes the company’s autonomous electric fleet (Cruise & Bolts), car sharing (Maven), and connectivity (OnStar). The company is also very profitable, which makes its shares very undervalued and its dividend very safe.