(Nov 25): The Global Portfolio did quite well over the past one week, rising 1.8% and outperforming the MSCI World Net Return Index’s 0.3% gain. US stocks continued to inch higher to fresh record highs. The current investing landscape is positive for stocks with strong consumption supported by rising wages and a tight labour market while the mone­tary policy remains accommodative, with inflation staying low.

Shares in ServiceNow and, to a lesser extent, Adobe, which have underperformed since our acquisition, have regained lost ground on the back of renewed investor in­ terest. The former surged 11.4% last week after the stock was added to the Standard & Poor’s 500, thereby expanding its investor base to index funds.

Meanwhile, Disney saw mild profit­-tak­ing, on the heels of the previous week’s 13.3% gain. Sentiment for the stock strength­ened after the company reported significant­ly stronger-­than­-expected subscriber sign­-up — more than 10 million — for its new streaming service Disney+ on its first day of launch. Given its strong run, we decided to lock in some profits, selling half of our hold­ings and netting a smart 21.6% return.

We also disposed of half of our holdings in Dollar General for a gain of 15.3%. You would have noticed that we have been par­ ing back our exposure to the US consumer sector in recent weeks. We were ahead of the market by investing in this sector. As others move in, it is time for us to move ahead.

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In addition, we sold all our shares in PayPal and Square for a combined profit of US$930 ($1,266). We have not changed our views on the long­term outlook for the on­ line and mobile payments industry or under­ lying fundamentals for both companies. But, as previously articulated, we believe cyclical stocks will see better upside in the near term.

As such, we have reinvested proceeds into banking stocks, Comerica and JPMorgan Chase & Co. We also increased our in­vestments in Alibaba Group Holding, on expectations that the stock will do well post its secondary listing on the Hong Kong Stock Exchange.

Our recent acquisitions have performed quite well. Shares in The Boeing Co are up 3.3% from our cost while those in Builders FirstSource and BMC Stock Holdings have risen 3.4% and 3.2% respectively in just over a week.

Last week’s gains lifted total portfolio re­ turns to 14.4% since inception. By compar­ison, the benchmark index is up 12.3%.

Builders FirstSource

We have decided to take a second bite at BFS on an improving outlook for the US housing market as recession fears recede.

The median sales price for US homes has been trending down from the peak in 4Q2014, from US$337,000 to US$310,000 in 3Q2019. Low mortgage rates and higher wages further translate into increased housing af­fordability. The current 30­year mortgage rate is the lowest in two decades, at 3.75%, com­ pared with the 10­ and 20­year historical av­erages of 4.11% and 5.24% respectively.

Recent housing data has been encouraging (see Table 1). Leading homebuilders are reporting positive growth for new home or­ ders, which should translate into stronger demand for building products. To recap, BFS is one of the leading lum­ber and building materials suppliers in the US. The company’s focus on value­-add­ed products — such as cabinets, deck­ing, doors and fireplaces — has resulted in gross margin expansion over the past five years, from 22% in 2014 to 27% currently. Enhanced cash flow, in turn, lightened its debt burden from eight times debt-­to-equity to just times times over the same period.

As the company moves away from dependence on lumber trading, BFS is also less susceptible to commodity deflation and gains better earnings visibility from the value­-added segment sales. Lumber­-relat­ed sales dropped to 30.6% of total sales in September from 36% two years ago.

That said, it did not escape unscathed. Commodity deflation dragged down sales by 6.5% y-­o-­y in 3Q2019. But net income improved 6.6%, thanks to increased vol­ume sales for higher­margin value-­add ed products. So far this year, the company has invested US$73 million in both green­ and brownfield projects for additional val­ue-­added manufacturing capacity, including roof trusses, walls and floor panels.

BFS is the second­-largest distributor in the US, with a 7% share in a highly frag­ mented market, where small local suppliers account for about 80% of total sales. BFS’s strength is in its wide area of coverage — its distribution network spans across 400 locations in 40 states.

BMC Stock Holdings

BMC is another leading building products dealer in the US. Like BFS, the company has also been shifting away from reliance on lum­ber trading to value­-added products, such as millwork, windows, remodelling and doors.

Lumber now accounts for only 28.5% of sales. Gross margin improved from 23.5% in March 2017 to 26.4% at present. Together with better cost control, internal optimisation and purchasing rigour, net margin expanded by 2% to 5.2% over the past two years.

BMC is a debt­-light company with only 30% net gearing. This gives the company flexibility to expand via acquisitions. It has identified a potential acquisition pipeline of 400 companies, with annual sales of more than US$25 million each.

By investing in both BFS and BMC, we gain a balanced exposure to 1) high profit­ ability through effective debt leverage and 2) high growth potential on strong balance sheet.

The Boeing Co

Shares in Boeing have underperformed the S&P 500 and Dow Jones Industrial Ave age so far this year. The reason, as we well know, is due to troubles surrounding the 737 MAX aircraft, following two fatal crashes. The planes have been grounded worldwide and new deliveries halted since March.

The company now expects to receive US Federal Aviation Administration approv­al for software fixes in December, which would enable it to resume deliveries. Air­ lines could then put the planes back into commercial service by late January after pi­lot training. That said, the three US airlines have pushed scheduled flights on that air­craft back to March 2020.

Even if all goes according to plan, Boe­ ing’s problems with the 737 MAX will not be entirely resolved for some time. Howev­er, successfully putting the planes back into the air would surely lift investor sentiment for the stock.

Long-­term demand for air travel — hence aircraft — is positive, on the back of rising incomes in emerging economies such as India, Indonesia and China. Airports Councils International projects global air passenger to double by 2040. Asia­Pacific is expected to account for half of this growth, with emerging and developing countries taking a lion’s share of 60%. Boeing and Airbus control a combined 90% of the glob­ al commercial airline market.

The commercial airplanes segment ac­ counted for 65% of the company’s profits in 2018; service and maintenance work for both commercial and defence contributed some 21% of profits.

Boeing is also a major player in the US defence sector. The defence, space and se­curity segment accounted for more than 13% of profits last year. The outlook for de­fence spending is upbeat, given rising geo­political tensions worldwide and the rejuve­nation of ageing US defence programmes.

This is consistent with our investment thesis in Northrop Grumman. Larger costs of upgrading arsenal, ships and aircraft as well as increasing electronic contents in modern weaponries all point to bigger de­ fence budgets going forward. The current allocation for defence spending, at 3.16% of GDP, is still relatively low compared with long­term historical ratios (see chart below).

Boeing currently has a backlog of 5,488 airplanes worth US$397 billion and another US$21 billion backlog in service and main­ tenance. Defence, space and security back­ log stands at US$62 billion. The company notes that the total addressable market for the next 10 years is worth US$8.7 trillion.


Tong Kooi Ong is chairman of The Edge Media Group, which owns The Edge Singapore
 
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