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Investment Strategy

A Remembrance of Picks Past

By Elliott H. Gue, on Jan. 26, 2018

It’s been fun. As Capitalist Times Premium winds down, it’s time to revisit our picks from the last 15 months, check how our performance stacked up relative to the S&P 500, and update our thoughts on these names.

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Rollins (NYSE: ROL), serves more than 2 million businesses and households worldwide and boasts the No. 1 commercial and residential pest-control franchises and the No. 2 termite-control business in North America.

The company has generated year-over-year net income and revenue growth in 41 consecutive quarters, usually in the low to mid-single digits. This impressive winning streak stems primarily from operational excellence, a recognizable brand (Orkin), resilient demand growth and a track record of smart acquisitions that don’t venture too far from the company’s core expertise.

Given the health risks and structural damage that pest infestations can cause, residential customers don’t regard payments to control the barbarian hordes of bugs and rodents as discretionary. The same goes for hotels, restaurants and other commercial clients where an infestation can cause significant reputational damage.

Rollins has outperformed significantly since we profiled the stock on Oct. 28, 2017, delivering a total return of more than 67 percent. The company has continued to execute and create value for shareholders, adding 12 international franchises and consolidating the fragmented US pest-control market via tuck-in acquisitions. Rollins recently announced a 21 percent increase to its quarterly dividend.

Highly resilient demand for pest control services, coupled with organic growth opportunities and smart acquisitions, should enable Rollins to increase its revenue by 4 to 6 percent annually while paying a healthy dividend and repurchasing shares.

Although the business of eliminating pests from businesses and households may not be sexy, this model generates a significant proportion of recurring revenue and lends itself to compounding returns over the intermediate term.

Investors sitting on big gains may want to take a partial profit and let the rest ride.

Fomento Economico Mexicano’s (Mexico City: FEMSAUBD, NYSE: FMX) American depositary receipt (ADR) trades with ample liquidity and stands to benefit from its retail segment’s long runway of growth opportunities and the potential monetization of its 20 percent interest in Heineken (Amsterdam: HEIA, OTC: HEINY).

The company generates about half of its annual operating revenue from its 48 percent interest in Coca-Cola FEMSA (Mexico City: NYSE: KOF), which bottles and distributes a wide range of branded beverages in Mexico, Central America, South America and the Philippines. This business represents about 13 percent of Coca-Cola Co’s (NYSE: KO) global volume.

Future growth opportunities for this business come from diversifying into new beverage categories and the potential acquisition of other bottling operations in Latin America and other regions.

Fomento Economico Mexicano continues to plow the free cash flow generated by its interest in Coca-Cola FEMSA into the three retail segments that account for the remaining 50 percent of its operating revenue: convenience stores, drugstores and gasoline stations. Coca-Cola’s FEMSA’s products receive preferred shelf space at these retail outlets.

The company’s OXXO-branded convenience stores generate strong profit margins, thanks in part to the scale advantages that come with being the industry’s largest player in the Americas. Fomento Economico Mexicano has ample opportunity to grow its store count at home and throughout Latin America, while the deregulation of Mexico’s energy industry creates opportunities in retail gasoline.

When we highlighted Fomento Economico Mexicano in Dec. 2016, we took advantage of weakness in the peso and Mexican equities that occurred after Donald Trump won the presidential election. Although the stock has outperformed since then, the valuation doesn’t look stretched and the growth story remains intact.

Fomento Economico Mexicano’s ADR rates a buy below $95, a price point that the stock could hit in a selloff related the renegotiation of the North American Free Trade Agreement.

Whereas Rollins and Fomento Economico Mexicano have outperformed the market, Manhattan Associates (NSDQ: MANH) has lagged considerably since we highlighted the stock as a value play in December 2017.

Manhattan Associates pairs internally developed enterprise software with corresponding business services to help retailers reduce their costs while delivering the convenience and instant gratification that today’s consumers demand.

The company’s suite of products and services enable retailers, wholesalers and manufacturers to optimize their supply chains, make informed decisions about inventory levels and locations, and meet consumers’ expectations for service and convenience.

These software packages crunch a welter of historical and incoming data to help these organizations reduce transportation costs throughout their network, improve the productivity of warehouse and distribution centers, match inventory with consumer demand centrally and at the local level, and provide information about product availability to improve the customer experience.

Although the company has reported strong uptake for its Omni Active solution and expects sales of cloud-based services to double to between 25 and 30 percent of its overall software revenue, 2018 looks like another transition year. Manhattan Associates rates a Sell; investors may want to return to this name down the line.

Earlier this year, we highlighted Ollie’s Bargain Outlet (NSDQ: OLLI) as a retailer that could continue to thrive in the age of Amazon.com (NSDQ: AMZN) The discounter offers a compelling in-store shopping experience, keeps costs under control and can grow rapidly over the next several years by opening additional locations.

Since we profiled the company in the Jan. 19, 2017, issue of Capitalist Times Premium, the stock has trounced the S&P 500. Investors may want to take a partial profit off the table, but we see more upside for the company.

The sales productivity of Ollie’s Bargain Outlet’s new stores has gained momentum in recent quarters, which bodes well for management’s plan to grow the location count by the mid-teens in 2018. All signs point to another year of 20 percent growth in net income—and that doesn’t even factor in the benefit of stock buybacks or the lower corporate tax rate. Ollie’s Bargain Outlet rates a buy on pullbacks below $55.

Anheuser-Busch InBev’s (NYSE: BUD) unparalleled scale and experienced management team give the company a huge competitive advantage in capitalizing on long-term growth in emerging markets and turning the craft-beer headwind into a tailwind.

However, the beer giant posted disappointing third-quarter results, headlined by weakness in the US. Management attributed some of this slide to Hurricane-related disruptions, but all signs suggest that the growing preference for craft beer will continue to take its toll on the Anheuser-Busch InBev’s core products.

Sales in Brazil improved by almost 10 percent, suggesting that momentum has returned to this key market. Anheuser-Busch InBev rates a Hold for patient investors.

After delivering on plans to boost profitability by reducing costs, improving its product mix, and investing in innovation, Sealed Air (NYSE: SEE) has entered the show-me stage, where the market’s focus has shifted from margin improvement to delivering above-market revenue growth.

Last fall, the company completed the $3.2 billion sale of Sealed Air’s Diversey Care division and the food hygiene and cleaning business, eliminating a lower-margin operation that was outside the packaging outfit’s core competency. The packaging outfit bought back $677 million in stock and paid down $1.1 billion in debt, while acquiring companies in Brazil and Singapore.

We expect the company’s legacy business lines to benefit from growing demand for fresh and prepared foods at the grocery store and the rise of e-commerce. Sealed Air is a buy up to $48.

This summer, we highlighted Wesco International (NYSE: WCC) as a potential value play, taking advantage of a temporary swoon in the stock amid concerns about potential competition from Amazon Business—an overblown risk for an industrial distributor that generates 65 to 75 percent of its annual revenue from business tied to services and technical solutions.

The company also generates ample free cash flow and has a long history of unlocking value via acquisitions. We also thought that the market overlooked the progress that Wesco International has made in improving its profit margins, as well as the revenue upside associated with stepped-up spending by electric utilities and the construction of data centers.

Although spending by industrial customers has gained momentum, valuation concerns have prompted us to Sell the stock for a 22 percent gain since mid-July 2017.

PTC (NSDQ: PTC) brought the first commercial computer-aided design (CAD) product to market about 30 years-ago and the first web-enabled product life-cycle management (PLM) solution in the late 1990s.

These core businesses stand to benefit from the ongoing transition of its CAD, PLM and SLM customer base from perpetual licenses to a subscription model.

PTC’s ThingWorx platform has emerged as one of the leading software solutions for manufacturers and other industrial companies seeking to make the most of the big data generated by smart, connected products.

ThingWorx enables non-hardcore programmers to build applications that process, sort and analyze the data generated by the connected factory and product to enhance the efficiency of manufacturing facilities and predictive maintenance on their output. Given the reams of data generated and the number of apps that can be created, this software can reduce the time and cost of taking full advantage of the internet of things.

Although we continue to like PTC’s growth story, the stock has moved too far, too fast. Sell PTC and book a 37 percent gain since mid-August.

The $5.1 billion acquisition of Dow Chemical’s (NYSE: DOW) chlorine business in 2015 tripled Olin Corp’s(NYSE: OLN) chlor-alkali capacity and made the company the world’s leading producer of chlorine and caustic soda, markets that appear to have room to run in their current up-cycle. All told, Olin accounts for about one-third of global supply and operates roughly double the capacity of its closest competitor.

In addition to its superior scale, Olin’s presence in the US gives the chlor-alkali producer a significant leg up on the competition, thanks to its access to inexpensive electricity (a product of the shale gas revolution) and ethylene (via a five-year, at-cost supply agreement with Dow Chemical).

Chlor-alkali companies produce chlorine from brine (salt) and electricity, a process that rivals only aluminum production in power consumption. This electrochemical reaction also yields sodium-hydroxide, commonly referred to as caustic soda, in a 1.1-to-1 ratio. Caustic soda has applications in a wide variety of downstream markets, including pulp and paper, alumina refining, soaps and detergents, textiles, water treatment and metal processing.

Olin converts a large proportion of its chlorine output into ethylene dichloride and other vinyl intermediates that are used to make PVC resin. For this reason, the company’s fortunes hinge on developments in the markets for caustic soda and PVC.

The supply-demand balance in the global chlor-alkali market appears favorable, with minimal capacity additions planned and end-market demand growing in line with global GDP. Olin Corp rates a buy up to $40 for aggressive investors.

Thermo Fisher Scientific (NYSE: TMO) has built itself into the 800-pound gorilla in life-science tools and diagnostics through constant innovation and a history of savvy acquisitions that offer exposure to powerful secular growth trends.

Management has built a behemoth that aims to grow its revenue by 4 to 6 percent annually through 2020 and its adjusted earnings per share by 12 to 15 percent.

A revolution is also underway in the pharmaceutical industry, with companies increasingly focused on developing biologics—drugs synthesized using biological processes such as fermentation. The complexity of discovering, developing and manufacturing these treatments drives increased demand for equipment, consumables and outsourced services.

Thermo Fisher Scientific also provides investors with leverage to the emerging trend of precision medicine, a practice that considers a person’s genetic traits to diagnose health problems earlier and develop a personalized treatment regimen. Rapid advances in genetic testing over the past decade have lowered costs and brought these technologies into the midstream, providing Thermo Fisher Scientific with a durable tailwind.

The company has also established an impressive footprint in emerging markets where rising household incomes have increased demand for health care services, fueling ongoing investment in lab equipment and instruments. Consider that many of the diagnostic tests we take for granted in the developed world have yet to be ported over to emerging markets. China accounts for about half of Thermo Fisher Scientific’s emerging-market revenue and 10 percent of its overall sales, which continue to grow in the high single digits for life science tools and diagnostics.

Thermo Fisher Scientific rates a buy on pullbacks below $210. 

Peter Staas is managing editor of Conrad’s Utility Investor, Energy & Income Advisor and Deep Dive Investing.

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